I read an article in today’s USA Today that profiled several entrepreneurs who financed their business ventures with funds from their 401(k) accounts. Although the gamble has paid off – at least so far – for the business owners profiled, I think this type of action goes under the category of the adage “Just because we can, doesn’t mean we should.”
Now, I don’t mean to disparage any of these individuals, since using a 401(k) for start-up costs is perfectly legal. Under a ROBS loan (Rollovers as Business Start-ups), a new business creates its own 401(k) plan from savings in the owner’s individual 401(k). The “old” 401(k) money is used to buy company stock in the “new” 401(k), thus allowing the business owner to avoid early withdrawal taxes and penalties. Or, entrepreneurs can opt for a traditional plan loan.
However, I think both ideas are just too risky. I understand that entrepreneurs may feel like they have no other financing options, since banks still are being particularly tight-fisted. But I think using such means to launch a new and perhaps unproven venture – in a downturned economy, no less – ROBS Peter to pay Paul, so to speak. And in the end, I fear that using ROBS may cost business owners everything – their present livelihood and their future security.
Pros, let me know what you think about this – especially you financial advisers out there. Will ROBS steal entrepreneurs’ savings and their dreams? Would you/have you advised clients for or against them?
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6 Comment(s)
Posted by: markgoss | May 14, 2012 9:40 AM
I have never heard of the ROBS loan before. It sounds like another alternative to seeking out Atlanta title loans. I think it might be a positive thing for any start up business.
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Posted by: Emily Sharp Rains, Esq. | May 2, 2010 10:35 PM
I have long since been a proponent of offering employer securities to company retirement plans so long as the investment furthers the purpose of the retirement plan, namely to generate retirement for plan participants and the potential gains outweigh the risks.
ROBS promoters are the issue because they sell ROBS transactions, en masse. Because ROBS promoters represent themselves as industry experts who charge their customers a premium for a corporation and retirement plans, their clients are often reluctant to seek independent counsel to ensure that the transaction and the offering conform with both federal and state laws. In fact, entrepreneurs shouldn't pay a $5,000.00 price tag for an entity and a retirement plan prepared by unlicensed professionals or otherwise. In my experience, ROBS promoters routinely overlook the securities issues and rely on Rule 701 which does not apply to ROBS transactions. Employers that are represented by seasoned and experienced employee benefits attorneys with securities experience can properly direct their plan to purchase employer securities, when appropriate, incompliance with all the applicable federal and state laws.
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Posted by: CharlotteMaine | April 19, 2010 9:31 PM
That is just very much risky! Think what will happen to savers like us? I hope that won't happen to our retirement savings. My husband and I till have seven years in counting for our retirement on the normal retirement age. As our plan, we would settle in
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Posted by: Jerry K | February 17, 2010 6:18 PM
I haven't seen the article in USA Today, but I have read the October 1, 2008 memorandum that Michael D. Julianelle, IRS Director of Employee Plans, penned. The memo alerts IRS agents performing audit reviews and determination letter approvals to study each of these on a case-by-case basis, in order to verify if rules are being violated. Here is how the memorandum concluded:
"ROBS transactions may violate law in several regards. First, this scheme might create a prohibited transaction between the plan and its sponsor. At the time of the exchange between plan assets and newly-minted employer stock, the value of the capitalization of the entity is equivalent to the value of all plan assets, when in reality, the entity may be valueless and asset-less for an indefinite period of time. Additionally, this scheme may not satisfy the benefits, rights and features requirement of the Regulations. The primary utility of the arrangement may only be available to the business's principal individual."
"Specific facts will need to be evaluated on a case-by-case basis in order to make a proper determination as to whether these plans operationally comply with established law and guidance. Technical advice requests may be submitted after consultation with group managers. For this reason, employee plans specialists are directed to resolve open ROBS cases as described herein."
In other words, caveat emptor!
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Posted by: jerryp | February 17, 2010 5:43 PM
When I have advised clients on the use of the ROBS concept I have always cautioned them about the use of their retirement money for this purpose. However, in most cases my clients have been so committed to using their retirement plans for a new business that they are willing to withdraw the account balance and pay all of the related income tax and penalties.
I have justified the use of the rollover approach as a method to provide the client access to 100% of the account balance undimished by taxes. Perhaps retaining the use of an additional 40% of the account will lead to a better chance of success in the new venture.
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Posted by: ilene | February 17, 2010 2:45 PM
While its not the first thing I would recommend to a client, the fact is that many jobs that have been eliminated are NOT COMING BACK. Starting their own business may be their only source of income, and sadly, for far too many, their 401K plan may be their only source of funding.
What I DO emphasize is to limit the funds to 10% of what they have so that if the business doesn't succeed, they can generally recover what they invested in a couple years.
Unfortunately, the fact is that for someone who has lost their job, particularly these days, they can't get money out of their house, and once their unemployment insurance ends, most don't have enough in savings to live more than a couple months. Using that money to start a business may be the only way to survive, and if they do it while on unemployment, may have time to get it to positive cash flow.
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