Most people don’t know that you can invest your 401(k) in a lot more than stocks, bonds and mutual funds. And one of those things happens to be investing your retirement money in your startup business. That’s where companies like IRA Financial Group and Guidant Financial come in — they are financial consulting firms that can help you use your 401(k) to finance the launch of your own business, without taking a taxable distribution.
There are two ways to fund a startup business using a 401(k), says Adam Bergman, a tax attorney and partner at IRA Financial Group. The first way is through a loan. A 401(k) plan allows to you to borrow up to $50,000, or 50 percent of your 401(k)’s total balance, whichever is less. A participant can use that loan for any purpose.
“I always ask my clients, ‘If all you need is $20,000 or $30,000 for your business, why don’t you arrange a loan from your 401(k)?’ says Bergman “It’s quicker, easier and cheaper, and since it is a loan, you are paying your plan back and not a bank or a credit card.”
But if you need more than $50,000, the second option is to use a strategy called Rollovers for Business Startups (or ROBS, for short). This is an IRS structure that allows a person to form a new C Corporation, adopt a 401(k) plan and use those retirement funds to invest in their startup business.
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The ROBS structure is a risky proposition that is not for everyone. If you choose the C Corp solution, you want to make sure you are working with a tax attorney who can help you set up the structure properly to maintain Internal Revenue Service compliance.
Guidant Financial co-CEO Jeremy Ames says there are a number of legal requirements that have to be established before a person can invest their 401(k) funds under the ROBS structure:
1. You have to structure your business as C Corporation and establish a corporate 401(k) retirement account. You can then rollover your outside retirement accounts into the new corporate plan. Your C Corporation now has the money to finance your business and other expenditures.
2. Your company must be based on a legitimate business idea. The C Corporation cannot be a hobby. It has to be a viable business that’s designed to generate profits.
3. You have to meet the IRS requirements of a qualified plan. The IRS created prohibitive transaction rules to prevent an individual from rolling over the distribution and using the retirement funds to purchase personal assets.
Professional guidance is critical in setting up an IRS-compliant legal structure that you can use to invest retirement funds in your business. “First, and foremost, make sure you do your due diligence on the company you’re going to work with to help you do this,” advises Ames, “because at the end of the day, this is all about your business.”