A Bad Lending Environment And Provisions In The Tax Code Make Tapping Retirement Funds A Tempting Start
Were you laid off over the past couple of years and sick of the job-hunting circus? Have the itch to start up your own business but know there’s no chance in hell you’re getting a bank loan? Tired of watching your retirement funds whipsaw with the stock market?
If you answered “yes” to these questions – and there are surely a lot of you out there in this economy – you might already be considering tapping into your 401 to start a business. And thanks to provisions in the tax code, you can do so without penalty if you follow the right steps.
But don’t get too excited: This financing technique isn’t for everyone. Here’s what you need to know.
Financing a Start-Up with Your 401: The Process
The steps to financing a business with your retirement savings are simple enough, but legally are a bit complex. The first action is to establish a C corporation that has created but not issued stock. The corporation then adopts a retirement plan. Specifically, what you want is a profit-sharing plan that allows 100 percent of the plan assets attributable to rollovers to be invested in employer stock.
A 401 can be tailored to meet these needs. Then, you rollover your retirement funds from your previous employer or IRA into the new 401 plan. The funds can come from multiple sources and even multiple people – maybe a spouse who will also be part of the business or former co-workers who were also laid off and are looking for a new opportunity. This can help you limit your risk.
Meet The Rainmaker Advantage Plan
The Rainmaker Advantage Plan® is the only of its kind. From the innovators of Rollover as Business Start-ups funding comes the next great solution for entrepreneurs. The Rainmaker Advantage Plan is a corporate capitalization funding strategy that lets you save for your future while continuing to invest into your business. Learn more
What To Know Before Borrowing Against Your 401
Entrepreneurs can withdraw from their 401s to start a business. This can often be a viable alternative or addition to business loans, investors, grants, and other sources of capital.
There are a few ways to use a 401 to fund a business, each with pros and cons. Find out if using this method of financing is right for you.
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Rollover For Business Startup
Rollover for Business Startups is the most likely route you can take to buy a business with your 401. This method allows you, as a future business owner, to tap into your retirement funds in a tax-advantaged way. This process ârolls overâ your existing retirement plan into the new company in exchange for stock that you issue to yourself. By far, the greatest advantage of using a ROBS is being able to invest your retirement savings in a small business entirely tax-free.
Setting up a ROBS is not overly complicated, but it is important to follow the procedure defined by the IRS in order to avoid tax complications or other compliance issues. There are providers who will provide the service for you for a rate of around $4,000.
These services, or any business accountant, can help you set up the required C Corporation paperwork and issuing the Qualified Employer Securities can be somewhat involved. Once it is set up, your retirement plan, now issued by the C Corp, purchases stock in the newly-formed company.
Many people find that they are able to set up a ROBS without paying for an all-inclusive service. In order to roll over your 401 into this structure, you need to follow five key steps.
What Is 401 Business Financing
401 business financing, also known as Rollovers for Business Startups , is a small business and franchise funding method. ROBS allows you to draw money from your retirement account in order to start or buy a business without incurring an early withdrawal fee or tax penalty. This is not a loan ROBS gives you access to your own money so you can build the life you want without going into debt.
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What Features Should I Have In A 401
Matching Contributions. Your company isnt required to make contributions to the plan, but you can choose to contribute a percentage of each employees pay, you can match the amount each contributes , or you can do both. Under a traditional 401, you can change the amount the company matches each year.
Automatic Enrollment. One increasingly popular feature of workplace retirement plans is automatic enrollment, as a way to increase employee participation. You can set up an individual plan for each employee, and automatically deduct retirement plan contributions from their paychecks. Each employee can opt out or change the amount over time.
Beginning Jan. 1, 2020, your business can qualify for a new tax credit of up to $500 for setting up a new auto-enrollment account, thanks to the SECURE Act law, which stands for Setting Every Community Up for Retirement Enhancement. It put into place numerous provisions intended to strengthen retirement security across the country. This auto-enrollment tax credit for employers is in addition to the startup credit described above, and its available for three years.
All employees must be 100%-vested by the time they attain normal retirement age, or when the plan is terminated.
Why Use Robs To Fund A New Business
Typically, withdrawing money from your retirement accounts before the age of 59 ½ results in penalties and income taxes to pay. But ROBS allows you to create a self-directed 401 retirement account that offers control over the investments in your portfolio so you can direct that money towards your new business venture tax free!
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You Can Still Grow Your Nest Egg
ROBS is also a tool for building your retirement assets. While using ROBS does mean youre taking money out of your retirement accounts, it also means putting cash back in. As you work within your business and pay yourself a salary, youll also be contributing a percentage of that salary into a 401, just like you do when youre an employee at any other company. This means your retirement assets will continue to grow as you build your business.
The Rollover For Business Start
The Rollover Business Start-Up Solution is an IRS and ERISA approved structure. It allows an individual to use retirement funds, such as an IRA or 401, to purchase a new or existing business or franchise tax and penalty-free.
The ROBS arrangement typically involves the following:
- Roll over a prior IRA or 401 plan account into a newly established 401 plan which a start-up C Corporation business sponsored
- Invest the rollover funds in the stock of the new C Corporation
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Alternatives To A Robs Plan
Although a ROBS plan would keep you out of debt, there are other ways to fund a startup that wouldnt put a large chunk of your retirement savings on the line. You could consider the following options. These are just a few ideas you might get more ideas for startup loans here. And if youre considering a ROBS plan because you want to use your own savings, not outside money, here are some other ways to bootstrap your startup.
A Robs Plan Can Be Used For More Than Just Start
While we have talked a lot about using ROBS plans to start up a business, they can also be used for other purposes. These plans can be a funding source to:
1) Buy an existing business
2) Recapitalize a business
3) Build a franchise
These plans can offer fast access to large amounts of capital without having to go through the traditional lending channels.
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How To Use A 401 To Start Or Buy A Business
Tom has 15 years of experience helping small businesses evaluate financing options. He shares this expertise in Fit Small Businesss financing content.
There are three ways you can use your 401 to start or buy a business. You can cash out funds, borrow against your 401, or use a rollover for business startups . The only option that does not result in penalties, taxes, or interest charges is a ROBS, making it ideal for most situations.
If you are considering using retirement funds to start a business, a ROBS allows you to use savings in your 401 or individual retirement account with no penalties or immediate tax obligations. If you have at least $50,000 in your retirement accounts, Guidant will offer a free ROBS consultation.
What Do Robs Cost
Based on our review of a dozen providers, the cost of a ROBS transaction can range from $4,000 to $5,000. That’s for the setup. There are also monthly fees to cover ongoing support and maintenance, including IRS reporting, eligibility tracking, and plan reconciliation. Those fees can range from $75 to $140 per month. Some providers charge a base monthly fee for a maximum number of employees and then add a charge for additional employees.
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Distribute Assets From 401k
Fill out the paperwork. You have the option of a partial withdrawal or a complete withdrawal depending on how much money you need to access.
Sign and submit the form. Distributions are added to annual gross income. Distributions before age 59 1/2 have an automatic 20 percent federal withholding and are assessed a 10 percent IRS penalty on top of income taxes.
Use the funds to buy the business.
Choosing A Skilled Robs Provider
ROBS providers are invaluable resources. If youre considering 401 business financing, a ROBS provider will not only help walk you through the setup phase, but the provider will also provide post-setup support. Because of the intricacies of this type of business financing, the IRS requires ongoing compliance, which includes monthly and annual reporting. Keeping up with these legal regulations is not for the inexperienced business person.
Consider these criteria when evaluating a potential ROBS provider:
- Setup fee. Each provider will quote you a setup fee for the initial cost of setting up your ROBS plan.
- Maintenance fees. These fees ensure that your ROBS plan maintains its compliance with IRS regulations, including any changes in tax legislation.
- Ongoing support. Look for a hands-on provider who stays on top of filing the proper paperwork on a timely basis and efficiently maintains your plan.
- Communication. Find a provider who will keep you in the loop by maintaining communication and one who is easy to contact when you have questions.
Some notable ROBS providers for 2019 are Guidant, FranFund, MySolo401k, Benetrends, Pango Financial, Catchfire Funding and Business Funding Trust.
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Use A 401 Business Loan To Finance A Business
If youre looking into using a 401 to start a businessâor finance an existing oneâyou might consider getting a 401 business loan, especially if you need less than $50,000 in financing and plan to stay employed for the time being. What is a 401 loan?
If your 401 or other eligible retirement plan allows loans, then the IRS permits you to borrow up to half of your vested balance, or $50,000âwhichever is less. This amount you borrow, therefore, is your 401 loan, which can be used for any eligible purpose, including business purposes. With this loan, you will be charged interest, however, since youre borrowing from your retirement plan, youre actually paying the principal and interest back to yourself.
The key with this type of 401 business financing, though, is that you have to remain employed and enrolled in your employer-sponsored retirement plan while the loan is outstanding. If you lose your job or decide to leave, youll have to pay back the full loan within two months. This being said, for most entrepreneurs, a 401 loan isnt practical unless theyre considering starting a business as a side gig for a while. In fact, most people use 401 loans not for business, but for personal expenses, such as medical bills or home renovation costs.
Best For Franchise Funding: Franfund
Ongoing monthly fee on the high end
FranFund was founded by former franchise owners with an eye toward helping aspiring franchise owners realize their dreams. That commitment, along with its long track record of securing financing for franchise owners, makes FranFund our choice as the best provider for franchise businesses.
FranFunds application process starts with a free consultation to determine the specifications of an applicant’s needs. With FranFund’s no-risk SafetyNet Program, applicants can roll over their retirement plan money at no cost. This gives the funding process a head start as applicants complete the remainder of the ROBS setup, with funding available in as little as 10 days. Applicants are under no obligation to complete the setup with FranFund.
Once the rollover is complete and the FranPlan is implemented, FranFunds provides an in-house TPA with a dedicated TPA associate to manage the plan and ensure it remains in compliance with IRS and DOL guidelines.
FranFund works with a broad network of SBA and traditional loan providers to help clients obtain additional financing.
FranFund claims that less than 1% of its plans have been audited by the IRS or DOL with no disqualifications. However, if your plan is subject to an audit, you have the full support of FranFund’s staff, including ERISA and tax attorneys.
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Open Business Owners Retirement Savings Account
Find a CPA that administers Business Owners Retirement Savings Account rollover Individual Retirement Accounts. This is a specialized IRA that allows the IRA to buy stock in a personal corporation. The CPA will not only set up the account, but must become the plan administrator.
Open a rollover IRA with the CPA designated as the Business Owners Retirement Savings Account.
Open a corporation in the state you reside in through the secretary of state. File articles of incorporation and pay any registration fees.
Instruct the CPA rollover administrator to buy stock in the new corporation. The money goes into the company operating accounts and the corporation sends the stock certificates of ownership to the CPA to hold in the IRA. Use the assets in the general operating account to purchase the new business.
Why You Would Need To Use Your 401
One of the major drawbacks to traditional funding is the amount of time it can take to secure funding depending on the organization, getting the money in your hands can take weeks or months. This is impractical when business-owners have time-sensitive deals putting off plans for a few weeks can financially destroy a startup.
Using your 401 allows for immediate funding without the hassle of dealing with loan offices. These offices may even deny you a loan after the process begins, slowing down funding even further.
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Using A 401 To Start A Business: What You Need To Know
If youre thinking about using a 401 to start a business, there are a few points youll want to keep in mind before you explore your different financing options.
To begin, youll want to remember that ordinarily, if you withdraw money out of a 401 or IRA before the age of 59 Â½, you have to pay income taxes on the money, plus a 10% early withdrawal penalty. Therefore, if youre wondering how to use your 401 to start a business, youre taking on a considerable amount of risk in doing so.
Luckily, however, short of simply withdrawing money from your retirement account, there are two better options that allow you to tap into your retirement funds without having to pay income taxes or penalties. First, you can take out a 401 loan to finance your businessâor, second, you can rollover your balance into a new 401, called ROBS, or rollovers as business startups.
In both of these cases, although you wont face the same taxes and penalties as taking directly from your account, there will nevertheless be inherent risk involvedâyoull risk losing your retirement savings if your business doesnt do well. Ultimately, whether or not you decide on using a 401 to start a business will depend on your personal level of risk tolerance and what you think is best for your future.
How Do I Create A 401 Plan
Creating a 401 plan for a companyeven a small oneis a complex process. The following is a basic overview of the steps for getting approval and starting the plan:
- Write a plan with the help of a plan adviser and send it to the IRS for a determination letter .
- Find a trustee to help you decide how to invest contributions and manage individual employee accounts.
- Begin making employer contributions, if offered, and allowing employee contributions through your payroll system.
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Best Customer Support: Guidant Financial
Contractual guarantee of free audit support
Extensive network of lending partners for additional financing needs
Pricing is a bit on the high end
Operating since 2003, Guidant Financial is one of the more established ROBS providers. Additionally, they now do more transactions each year than any other provider. That experience shows with the superior support it provides before and throughout the process, including its free access to outside counsel at any time. For that, Guidant makes our list as the provider with the best customer support.
Guidant’s application process begins with a free consultation during which applicants can get answers to all their questions. Applicants and clients also have access to attorneys throughout the process at no extra charge. Funds are typically available in as little as three weeks.
Once the ROBS transaction is complete, Guidant can act as your administrator or you can hire a third-party administrator for ongoing compliance support and Form 5500 filing. When the business is ready to be sold, Guidant is there to ensure the retirement plan is closed down properly and rolled into an IRA. That includes the preparation and filing of the final Form 5500.
Guidant boasts the lowest audit rate in the industry. Clients are guaranteed free outside counsel if they become subject to an audit.