Funding A Start-Up Business With Your 401(k)

A growing number of people who are tired of their jobs, or have recently lost their jobs, are converting their traditional 401(k)s into ROBS (rollovers as business start-ups) and using them to invest in entrepreneurial endeavors. 

The reasons is becoming more commonplace is that the real estate market is up, the stock market is up, and this offers a way to finance a business without taking on any debt. Therefore, in a market that has a large amount of unemployment and a credit crisis, ROBS can be an attractive way to start a business.

As in anything where the IRS is involved it isn’t as simple as it firsts sounds, and in many cases the potential benefits don’t outweigh the considerable risks. If ROBS are not accurately put in place they can be viewed as tax-avoidance schemes by the IRS, which could lead to fines and large tax rates for early withdrawal of a 401(k).

ROBS work by people taking a qualified retirement plan, such as a 401(k), and rolling it into a completely new plan, which in turn buys shares in an operating company.  This operating company will own the business, but instead of the business being set up as an LLC or S-corp, it must be set up as a C-corp.  Essentially, this means that the new plan owns the business, and the individual who is starting the business must act in the best interest of the plan and not necessarily in his own best interest. As a result, he isn’t able to make his salary as large as he wants but must find out what comparable business owners are being paid and adjust his pay accordingly.

It is important for people to do ample research before deciding whether ROBS is a good idea for them or not. There are numerous ways to get in trouble with the IRS, incur fees, and run into difficulties if you try to sell or dissolve the business.