How Your Retirement Account Can Finance a Franchise (ROBS)

By Priyanka Prakash

Posted : September 28, 2015

Category : How To

How Your Retirement Account Can Finance a Franchise (ROBS)
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What is a Rollover For Business Startups (ROBS)?

A Rollover for Business Startups (ROBS) is a tax-free and penalty-free way to transfer money from your retirement account into a new business. A 401(k), traditional IRA, 403(b), and many other retirement accounts are eligible (Roth IRAs are not eligible). You may hear ROBS also referred to as a Business Owners Retirement Savings Account (BORSA) or Entrepreneur Rollover Stock Ownership Plan (ERSOP).

Ordinarily, if you withdraw money from a 401(k) plan or other retirement account before you reach 59 ½ years of age, you have to pay taxes on the money and a 10 % early withdrawal penalty. ROBS was designed to provide more options for those wanting to start a business.

ROBS Can be Particularly Helpful When Starting a Franchise

Buying a franchise can be an excellent path to business ownership, but securing funds to open a franchise can be the biggest challenge.

You may be sitting on a pile of cash that can get you started: your retirement account. And because ROBS is free from taxes and penalties, it may be the answer you’re looking for. In fact, over 60 % of ROBS transactions are used to invest in a franchise according to FRANData!

While ROBS can be a great option for budding franchise owners, there are risks involved, and you should use professional assistance to make sure you don’t create tax or legal trouble for yourself.

Providers such as Guidant Financial, Benetrends, and SDCooper specialize in helping would-be franchise owners set up a ROBS transaction.

Steps in Setting up ROBS

There are 4 basic steps in setting up ROBS:

  1. Create a C corporation.
  2. The new corporation then starts its own 401(k) or profit sharing retirement plan. Eligible employees must be allowed to participate in the plan, with the option to purchase stock in the company.
  3. The business owner then rolls over funds from his or her existing retirement plan into the corporation’s newly created plan.
  4. The business owner directs the new plan to purchase stock in the company. The funds resulting from the sale of the stock may to used to start or purchase the franchise.

If these steps are done correctly, no taxes or early withdrawal penalties will be levied against you because money is simply moved from one tax-exempt vehicle (your personal retirement account) to another (the company retirement plan).

ROBS Pros & Cons

ROBS are growing in popularity. Since 2003, Guidant Financial has helped 10,000 entrepreneurs invest more than $3 billion in retirement assets into franchises and other small businesses. What’s so appealing about ROBS?

The Pros

Start your franchise debt-free, tax-free, and penalty-free

The main selling point of a ROBS is that it allows you to open your franchise using your own money.

A ROBS is not a loan, so you won’t be saddled with debt or interest payments. You can invest your franchise’s profits back into the business instead of using them to pay off debt, which can be critical to your franchise’s ultimate success. In addition, ROBS shields you from taxes and early withdrawal penalties that you would normally be subject to if you took an early distribution from your retirement account.

Although a ROBS isn’t a loan, the providers mentioned above do charge a fee for their services. You’re looking at about $5,000 upfront and then about $120 per year to keep the plan going. Some providers such as FranFund cater specifically to franchise owners and have lower annual costs. Given the size of the fees, it makes most sense to use ROBS only if you have at least $50,000 of retirement savings that you can roll over.

Keep in mind that startup costs for a franchise can be high, so if you don’t have a lot of money saved in your retirement account, a ROBS alone may not be sufficient to start operating.

Franchise profits will grow in a tax-advantaged account

Putting retirement funds into a franchise is risky because there’s always a chance that the franchise will fail, wiping out your hard earned savings. But if the risk pays off, and your franchise is profitable, you may end up with all the money you need, and then some, for retirement.

Since the company retirement plan owns stock in the franchise, the growth of your retirement account is tied to the success of the franchise. If the franchise does well, some of the profits will be funneled back into the company retirement account. After years of profits, you may find that your retirement savings have grown significantly.

A ROBS gives you control over the growth of your retirement funds because you are investing them in your own franchise, which you will manage on a day-to-day basis. When your retirement savings are tied to the success of your own franchise, that’s going to push you to work harder (note: you also have the option to invest the funds in other companies’ stocks or mutual funds if you choose to do so).

The Cons

Franchise failure can wipe out your nest egg

Just as the success of the franchise can grow your retirement savings, a failure of the franchise can cause you to lose all your retirement savings.

Most data indicate that franchises are more likely to be successful than independent businesses, but even once-popular franchises such as Quiznos and RadioShack are now struggling to survive.

If your franchise folds, the stock held by the company retirement plan becomes worthless, and you’re out of retirement money.

It’s always a good idea to have a Plan B when you use ROBS in case the franchise doesn’t work out as planned. For example, it may be wise to leave behind at least a small sum of money in your retirement account or to have other stocks/bonds that you can cash out if necessary.

You must administer a retirement plan for your employees

Once the company retirement plan is created, eligible employees must be permitted to participate. They must be allowed to contribute funds and have the option to purchase stock.

Normally, employees don’t exercise their option to purchase stock because the opportunity to buy and sell shares is pretty limited. However, you still have to educate employees about the plan, provide employees with plan documents, process contributions, and take care of any employer tax obligations related to the plan.

Whether or not your employees decide to participate, ROBS providers such as Guidant and FranFund will assist you along the way.

Higher risk of tax and legal penalties

There are a lot of tax and legal rules you need to follow when rolling over retirement funds. ROBS still operates in a gray zone when it comes to the IRS and Department of Labor (DOL), so you may be opening yourself up to a higher risk of auditing when you use this type of financing unless you do everything by the book.

That’s why it’s essential to get professional guidance when doing a ROBS, instead of striking out on your own. ROBS providers will help you with things like the administration of the retirement plan, required annual tax filings, and how and when to take a salary for yourself as the franchise owner.

Following these rules should help keep you out of trouble in most cases. If you are audited, ROBS providers say that they offer IRS and DOL audit assistance at no additional cost to the client.

The Bottom Line

One of the cardinal rules of saving for retirement is, “Don’t touch your nest egg.” However, under some circumstances, using a ROBS is a calculated risk that pays off by allowing you to start a franchise. It may even increase your retirement savings in the long run. The best way to proceed is to carefully weigh the pros and cons, and to have a Plan B for retirement if you do decide to use a ROBS.

About the author:

Priyanka Prakash is a business analyst and staff writer at Fit Small Business. She has experience working at a start-up and is interested in software and services that help small businesses succeed. Her areas of expertise include Help Desk software, small business lenders, and more.

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