Oxstones Investment Club™While lots of advisers don’t recommend it, ROBS rules allow retirement withdrawals to fund a business
Tom and Stacy Lee wanted to start a small health-care franchise in Vermont. But much of their money was tied up in retirement accounts—some $300,000 in funds they couldn’t withdraw without owing taxes on the withdrawals and a 10% penalty on early withdrawals.
The same was true for Lisa Bresko-Cordova and her husband, who dreamed of starting a bed-and-breakfast in Colorado.
Enter the “rollover as business startup plan,” or ROBS, a little-known and somewhat controversial way to cover business startup costs. In essence, a ROBS is a way for retirement-account owners to “access accumulated tax-deferred retirement funds without paying applicable distribution taxes,” as the IRS wrote in 2008. With a ROBS, would-be entrepreneurs fund their respective businesses by forming C corporations and adopting simple 401(k) plans typically set up by a third-party administrator that specializes in ROBS. The aspiring entrepreneurs then roll the money in their retirement accounts into a new 401(k) plan, and that 401(k) plan then purchases stock in the new corporation.
Lynn Dunston, a registered investment adviser in Denver, and the financial adviser for Ms. Bresko-Cordova and her husband, says he sees much to like about using a ROBS. It provides immediate and low-cost access to capital, which “can be a challenge,” he says. In addition, a ROBS isn’t a loan that has to be paid back to the 401(k) with interest.
As the business grows, Mr. Dunston says, the C corporation shares held in the 401(k) appreciate in a tax-deferred manner. Plus, once the ROBS user becomes an employee of the business, he or she can receive a salary and contribute to the 401(k) as a plan participant.
The Lees got the money they needed to start a Home Care Assistance franchise within a couple of weeks using a ROBS, according to their financial adviser, Vincent Barbera, managing partner with Newbridge Wealth Management, a registered investment adviser in Berwyn, Pa.
“We used our own pretax dollars and needed to take on no debt to launch the business,” Mr. Lee says. “Dividends from taxable profits can then be paid to our retirement account, which owns the stock in our C corporation. Essentially we are betting that our startup will outperform that same money sitting in mutual funds somewhere, and we get to work in a business which could also pay nice salaries to ourselves.”
ROBS have plenty of critics. Typically, financial advisers don’t urge clients to use money earmarked for retirement to fund what could be a risky, money-losing venture.
Craig Adamson, a financial adviser with TrueWealth Stewardship, an investment advisory firm in Marion, Iowa, says he would never allow a client to use a ROBS. “Retirement accounts should be for retirement,” Mr. Adamson says.
Another caveat: “They are heavily scrutinized by the IRS,” says Matthew Curfman, president and co-owner of Richmond Brothers, a registered investment adviser in Jackson, Mich.
An IRS 2010 report on ROBS states that the plans, “while not considered an abusive tax avoidance transaction, are questionable in that they may serve solely to benefit one individual’s exchange of tax-deferred assets for currently available funds.”
Where some users can get into trouble, experts say, is in the valuation that is assigned to their C Corporation shares. A would-be ROBS user must use a reasonable and independently determined valuation for any company stock purchased as part of the deal, says Jeremy Portnoff, a certified financial planner with Portnoff Financial, a registered investment adviser with offices in New Jersey and California. “This point is the tough one because what kind of value might a startup have that could result in the stock value for purposes of making the ROBS transaction happen,” he says. “There’s the rub.”
If a startup has assets that can be legitimately used for valuation, then a ROBS could be a useful way to get an operation going, says Mr. Portnoff. “Fundamentally I think the strategy is OK,” he says, “but the [would-be ROBS user] has to be extremely careful; otherwise they risk blowing up their entire IRA.”
Users also have to make sure they are not “deriving personal benefits above and beyond what is standard or expected from the role they’ll be playing with the new business,” says Mr. Dunston.
Setting up a ROBS can be expensive, too. Those who endorse the strategy recommend hiring experts both to oversee the process and to administer the new 401(k) after it is created—preferably a plan administrator that isn’t sales-oriented and that is well-versed in ROBS.
“If not done properly,” says Mr. Dunston, “it could raise IRS scrutiny and result in a taxable distribution from the new 401(k) plan.”
Walter Pardo, a financial adviser with Wealth Financial Partners in Basking Ridge, N.J., says ROBS might be a last option for those who cannot obtain financing through a lending institution.
“But investors need to do your homework and know the consequences,” Mr. Pardo says. “If anything, it’s best to expect the best but prepare for the worst.”
Mr. Powell is the editor of Retirement Weekly, a service of MarketWatch.com. Email him atreports@wsj.com.
Appeared in the April 24, 2017, print edition as ‘Startups ROB 401(k)s.’
https://www.wsj.com/articles/how-entrepreneurs-can-use-iras-to-finance-startups-1492999382
Tags: 401K, business startup, entrepreneurs, low-cost access to capital, retirement account, retirement funds, retirement withdrawals, ROBS rules, ROBS transaction