Posted about 6 years ago

ROBS 401k Small Business Financing Explained

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Real-estate agents, real-estate brokers or any entrepreneur seeking to fund their own new or existing business (e.g., a real estate operating company) using their own retirement funds may be interested in exploring the rollover as business startup (ROBS 401k/PSP) vehicle.

This blog post covers the pros and cons, the rules to consider before and after the ROBS transaction, and the IRS’s view surrounding the ROBS transaction.

ROBS Defined

An entrepreneur such as a real estate agent or brokers seeks to fund his or her own business with retirement funds after having accumulated a good chunk of funds in an IRA and/or former employer qualified plan such as a 401k or 403(b). While 401k franchise financing is the popular reason that small business owners utilize the ROBS business financing strategy, other business types can and also use the ROBS design.

Summary of the ROBS 401k Small Business Financing Transaction

New C-Corporation formed that then sponsors a 401k plan.

The 401k plan document contains specific language allowing the participant(s) to invest rollover funds from other retirement plans in employer stock.

Often the entrepreneur is the sole employee of the C-Corporation and the only participant in the 401k plan.

The entrepreneur completes forms to formally roll-over or transfers funds from his or her former employer qualified plan or IRA(s) to the new 401k plan. As a result because funds have been moved from one tax shelter (IRA or former employer 401k, for example) account to another (the new 401k created for the new C-Corporation), the movement of the retirement funds is not deemed a taxable distribution.

The entrepreneur as the participant in the new 401k plan directs his or her funds into purchase of newly created C-Corporation stock, so now the 401k plan owns the C-Corporation stock. With the funds, the C-Corporation is now able to purchase a franchise or start another type of business.

The ROBS transaction Pros

Avenue to fund a business without debt since retirement funds are used.

Approach to continue to grow your retirement funds while at the same time taking a fair salary.

Make annual contributions to 401k as well as have option to invest in alternative investments such as real estate, tax lines, trust deeds, commodities and equities.

As your business grows and hire employees, the new employees will have option to participate in the 401k.

The ROBS transaction Cons

If the business fails you lose your retirement funds.

You are more likely to get audited as the IRS is concerned with prohibited transactions and ensuring that annual nondiscrimination testing is annually performed and employees are offered the option to participate in the 401k.

Rules to Consider Before the ROBS Transaction

Compliance before the ROBS transaction is important. Therefore, make sure to work with a competent attorney and 401k professional when structuring your ROBS transaction.

For example, specific language in the 401k Plan document pertaining to the use of rollover funds for the purchase of employer stock is required.

An appraisal of the C-Corporation, the shares of which the 401k is purchasing, may be necessary in order to confirm that the 401k is receiving adequate consideration.

During the ROBS Transaction

Ongoing administration is required. This includes annual Plan testing (known as nondiscrimination testing)--, governmental reporting (filing of annual Form 5500 and other documents), and communication of the 401k plan to employees.

After the ROBS Transaction

If you decide to sell the 401k plan’s stake in the corporation, the shares have to be sold at fair market value and thus an appraisal is required before the sale is consummated.

IRS Take on ROBS

The IRS is concerned with:

Prohibited transactions before, during and after the transaction

Failure to perform nondiscrimination testing

Valuation of the employer securities

Failure to communicate 401k plan to new or existing employees

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To learn more about how to finance a business using retirement funds Click Here, or call 800-489-7571.



Comments (5)

  1. I am considering purchasing an income property that I would manage myself. What if in the first two years I do not have any employees other than myself and I don't want to draw a salary (reinvest the profits).


  2. Mark, Do you have a source for the steps to terminate a ROBS?  I see where you say you need an appraisal and to sell the shares at FMV to terminate the ROBS. I have a client that wants to terminate their ROBS, and I'm having a very hard time finding primary sources that provide steps for terminating a ROBS.


  3. Hi Isaac,

    Good question. No as this type or arrangement only works with a 401k plan. Therefore, you would need to transfer your SDIRA to a ROBS 401k and then the 401k would purchase stock in your business, which would allow you to draw a fair salary since you would be a  W-2 employee of the 401k funded business.


  4. Hey @Mark Nolan, thanks for this great article! I'm curious -- will this strategy allow me to use SDIRA funds to build a real estate portfolio while drawing a "salary" for the time involved? My concern with a SDIRA is that I'd be spending a lot of time directing funds that won't be touchable for another forty years, so I'm curious whether or not I can be compensated from the returns on a property in the meantime.


    1. Good question. Unfortunately, the IRA rules do not allow for the IRA participant to receive compensation for managing the IRA. What is more, it is prohibited for the IRA participant to perform sweat equity work on the IRA owned assets.  If you are looking to run a real estate operating company using retirement funds, however, the IRA can the transferred to the ROBS 401k and you can then perform both managerial and sweat equity work and receive w-2 compensation for doing so.