EDITORS VIEW

The Rollover as Business Start-Up

StrategyShould Your Client
Use Retirement Rollover Funds
to Finance a Business?
by Kenn Beam Tacchino, JD, LLM, RICP

Clients may want to start a business but lack the

set-up capital to do so. Whats more, getting a business
start-up loan or a government-backed Small Business
Administration loan also is contingent on having personal seed money to start the business. One creative way
to work around this problem is to use funds from an
existing 401(k) plan or conduit IRA as the down payment needed to start the new business. In the current
business environment some planners and franchise promoters are advocating this so-called rollover as business
start-up (ROBS) strategy as a way for a client to gain
access to funds in a timely manner with no loan repayments needed. Since 2005 more than 10,000 business
start-ups have been financed by using ROBS.1 Perhaps
because of the strategys growing popularity the practice
has come under heavy IRS scrutiny. An audit by the
Employee Plans Compliance Unit (EPCU) concluded
the ROBS strategy was not an abusive tax avoidance
transaction per se, but ROBS should be closely examined on a case-by-case basis because they serve solely
to exchange tax-deferred assets for currently available
funds.2 The study found that many of the companies
had gone out of business in the first 3 years of operation and consequently the retirement assets were lost.
Advocates of the strategy, however, point to success stories where the client has started a business which was a
life-fulfilling dream for himself or herself as well as a
job-creating economic boon for the community.
To get a good feel for how ROBS are being used

ABSTRACT
Planning for the small-business owner requires a financial planner to wear many hats.
Financial planners perform a variety of tasks
to ensure that the business runs smoothly
and has the proper benefits in place, and to
guarantee that the business continues after
an owners death. However, before planners
get to help out with current and future operations of the small business, they may be
called upon to help create the business in the
first place. A unique method currently being
used to create small businesses is using a
qualified retirement plan rollover to start
the new business. The rollover as business
start-up strategy (commonly referred to
as ROBS) poses some challenging financial
planning issues. Some believe ROBS are
misused rollovers destined to wreck retirement (and potentially an abusive tax practice) and others believe ROBS may be the
fuel needed to help the client reach his or
her dream of business ownership. Devil or
angel; we will take a closer look.

Vol. 69, No. 4 | pp. 7-10

This issue of the Journal went to press in June 2015.
Copyright 2015, Society of Financial Service Professionals.
All rights reserved.

JOURNAL OF FINANCIAL SERVICE PROFESSIONALS | JULY 2015

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EDITORS VIEW

it is helpful to look at the following excerpt from the

EPCU Project:3
The ROBS plans we looked at spanned a cross section of businesses including those in senior care,
cleaning services, fitness, health food, real estate,
machinery, daycare, pet products and services, and
consulting. Some ROBS were start-ups while others were purchases of existing businessesSome of
the ROBS were franchises while others were standalone businesses. Some of the ROBS were started
by individuals who had worked in the same field
before starting a business of their own, while others
had just started a business for the first time.
In this column we will first identify how the
ROBS strategy works. Then we will examine the initial and annual compliance issues required to keep the
program in the good graces of the IRS and the Department of Labor (DOL). And finally we will analyze the
merits of recommending such a strategy to a client.

ployee. He or she then elects a direct transfer to move

funds from his or her existing plan where he or she
was formerly an employee (or a conduit IRA) to the
new plan which he or she will own and run. Since a
properly executed rollover or direct transfer is used, no
taxes or excise taxes (e.g., the 10 percent penalty) are
due. The next step is to direct the account to purchase
all of the newly issued corporate stock, which is now
held as a plan asset with a value equal to the rollover
funds received. It is important at this juncture that the
price per share should be determined by a professional
appraiser and that the employer stock is valued to reflect the amount of plan assets that the client wishes to
access. Also be aware that in early applications of the
ROBS strategy the plan was amended after the initial
purchase of corporate stock to not allow new employees to roll over funds and purchase stock. However,
the IRS has pointed out that barring employees from
purchasing stock violates the Employee Retirement
Income Security Act (ERISA) requirement not to discriminate with regard to the plans benefits, rights,
and features. Once the rollover of funds is completed
the next step in the ROBS strategy is to use the rollover
funds to buy or start the business. Finally, in a traditional corporation the business would typically then
pay a portion of the company assets to the promoter as
a professional fee. However, it is unclear whether paying the promoter with rolled over funds may be a prohibited transaction so it is probably best to make this
payment from borrowed funds or the entrepreneurs
personal accounts, or to avoid the promoter payment
altogether and/or seek a prohibited transaction exemption from the DOL when a promoter fee is paid.

How the ROBS Strategy Works

In order for a client to carry out the ROBS strategy
he or she must first establish a shell corporation.4 The
corporation must meet the rules under subchapter C
of the Internal Revenue Code. In other words it must
be a C corporation and cannot be an S corporation,
limited liability company (LLC), sole proprietorship,
partnership, or any other business form. Creating a C
corporation entails activities such as getting an employer identification number from the IRS, setting up
a corporate charter and by-laws under state law, creating a board of directors, and holding directors meetings. At this point in time the shell corporation has
no employees, assets, or operations. An initial board of
directors meeting must be held and minutes from the
meeting should show the adoption of a profit-sharing
401(k) plan as well as the authorization for employer
stock.5 The 401(k) plan needs to be designed correctly.
It must accept rollovers and direct transfers and it must
provide that all participants may invest the entirety of
their account balances in employer stock. Next, the
entrepreneur becomes the shell corporations only em-

Initial and Annual

Compliance Issues for ROBS
A variety of possible operational defects (red
flags) need to be deftly addressed when the plan is
established and in the following years. An IRS memorandum provides a look at the potential pitfalls.6
Common mistakes include:
Failing to notify rank and file employees of their

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EDITORS VIEW

right to participate in the plan (once the business

hires employees).
Not filing the corporate tax return (Form 1120).
Terminating the plan a within a few years of its
inception (this violates the so-called permanency
requirement of ERISA).
Using assets for personal (nonbusiness) purposes.
Discriminating with regard to the plans benefits, rights, and features (for example, the right
to acquire employer stock).
Improperly valuing employer stock.
Not filing annual reports (the 5500 or 5500EZ forms).
Annual compliance responsibilities include meetings
to comply with corporate laws, following all IRS and
DOL regulations for the qualified plans, and performing all administrative duties of the qualified plan and the
corporate charter. A key mistake uncovered by the EPCU
audit was that some sponsors of ROBS did not file the
5500 form because they were incorrectly advised they did
not have an annual filing requirement. In actuality there
is a special exception in the Form 5500-EZ instructions
that applies when plan assets are less than $250,000 and
the plan covers only an individual or an individual and
his or her spouse. In a ROBS arrangement, however, the
plan, through its company stock investments, rather than
the individual, owns the trade or business. Therefore, this
filing exception does not apply to a ROBS plan and the
annual Form 5500 or 5500-EZ (5500-SF for filing electronically) is still required.7

The safe answer, however, may not be the right

one for a client who dreams of owning his or her own
business but lacks funding. The ROBS strategy allows
for the use of capital which is otherwise locked away.
The client, who takes a chance on himself or herself
to go from being an employee to becoming a business
owner, may be making the best move of his or her life
from a financial and emotional standpoint. To be fair
it must be stated that ROBS are a better alternative to
cashing out the 401(k) and then using the funds to
purchase a new business because taxes and sometimes
penalties will apply (this also reduces the money available).8 The fact that the entrepreneurial client gets to
purchase or capitalize a new business without incurring taxes and penalties and/or having onerous loans
to pay back in the crucial early years of operation may
be the key to the businesss ultimate success.
So is the ROBS strategy a retirement killer or an attractive way to start a new business and take control over a
career? Is it a devil or an angel? The answer, of course, is:
it depends. A thorough analysis of the disadvantages and
advantages must be discussed with the client (see Table 1).
Beyond just looking at the disadvantages and advantages of the decision, the planner needs to help
the client properly analyze a plethora of factors which
include the following:
The risk aversion nature of the clientROBS are
not for the fainthearted, since a high percentage
of business start-ups fail.
The other income available for living expenses (e.g., the spouses salary)Will the client be
able to pay his or her bills before the business
reaches profitability?
The potential for business successobviously this
question is the elephant in the room. It all starts
with a solid business plan. However, a solid business plan does not guarantee success. In addition,
if success is possible, the question of how long it
will take to reach the promised land needs to be
considered to determine if the clients income and
assets will support him or her in the meantime.
The current business conditions and the clients

Is the ROBS Strategy a Good Idea?

The safe answer is probably not. A thorough
analysis of the possibility for a new businesss success
will often reveal that the odds are against the business succeeding. The worst case scenario of a client
forfeiting his or her accrued retirement funds and/
or going bankrupt is a realistic possibility. Keep in
mind that if your client Joe rolls over $50,000 from
his 401(k) plan to use the ROBS strategy when he is
40 years old and the business fails, he will have lost
the potential to have over $214,000 at an aged 65
retirement (assuming a 6 percent rate of return).

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EDITORS VIEW

prior experienceThe more favorable the business climate and the more experienced the client,
the more likely the strategy will work.
The amount needed to seed the businessWhat
percentage of the retirement nest egg is being
risked? It will be more acceptable to advise a
client to use the ROBS strategy if only a small
percentage of his or her retirement funds is being
used and remaining funds can be used as a partial rollover to a well-diversified IRA.
The other resources available for retirement from
a spouse or potential future legacyA client may
be more likely to withstand a business failure and
still be able to retire with financial security if he
or she has a safety net available, such as substantial pension from a spouse. Alternatively, in a best
case scenario the client would be rolling over funds
that were above and beyond those that were needed
for retirement. Also, if a legacy is certain (and that
may be impossible to determine) the planner will be
more comfortable recommending the ROBS strat-

egy if the client is able to replace retirement funds

with the legacy; in other words, effectively take his
or her legacy early to start the business.
The age of the clientDoes starting early in the
clients career give him or her time to make up
for lost ground if things go bad, or does starting
too late in the clients career doom retirement?
So, what will it be? Are you a dream maker or retirement breaker? The planners can say they covered
themselves by making all the appropriate disclaimers
and analyzing the business plan and the other issues;
but in the end giving clients approval to swim in the
deep end can weigh heavily on your conscience if they
go under. Analyzing the issue from every angle is only
the start of the process. You need to provide the objective eyes through which the ROBS strategy is viewed.
You need to examine all the contingencies. And you
need to work with the client to come to the decision.
There are no guarantees or right answers, just better
answers through well-thought-out planning. n
Kenn Beam Tacchino, JD, LLM, RICP, is a professor of
taxation and financial planning at Widener University in
Chester, PA. Professor Tacchino has won awards for both
his teaching and his scholarly writing. Among other consulting activities, he conducts retirement planning seminars for employee groups. Professor Tacchino can be
reached at kbtacchino@widener.edu.

TABLE 1
Disadvantages and Advantages of ROBS

Disadvantages

Advantages

Very riskyCould lose

retirement funds if the
business is unsuccessful

Access to funds for the

business

Diversification nightmarenot a prudent investment for retirement

Could prove to be a
wise investment

ROBS are a compliance

minefield (there is a
heightened level of IRS
scrutiny)

Avoids taxes and penalties of withdrawal

ROBS are costly to start

and administer (fees can
run $5,000 to pay for
start-up costs, accounting costs, appraisals,
and 5500 filings.)

Funds have been

transferred from one
tax-advantaged plan to
another and have been
invested in the business
to give it the needed
start-up money

(1) Thomas Wechter, Rollovers as Business Startups: A Guide to

Using Retirement Funds to Start a Business, AICPA Store, October 2013, page 1; accessed at www.cpa2biz.com.
(2) Employee Plans Compliance Unit (EPCU)-Completed Projects-Project with Summary Report-Rollovers as Business Start-Ups (ROBS), accessed at: irs.gov, page last reviewed or updated in December 2014, page 1.
(3) Ibid.
(4) An excellent blueprint for establishing ROBS is provided in a
Memorandum from the EPCU. Michael D. Julianelle, Guidelines Regarding Rollovers as Business Start-Ups, October 2008;
accessed at: http://www.irs.gov/pub/irs-tege/robs_guidelines.pdf.
(5) It doesnt have to be a 401(k) plan. Technically other defined-contribution plans work; however, most ROBS use a 401(k) plan.
(6) Julianelle 2008, endnote 4.
(7) Employee Plans Compliance Unit (EPCU)-Completed Projects, endnote 2.
(8) For example, assuming the client is in the 30 percent federal and state
marginal tax bracket and is required to pay a 10 percent early withdrawal
penalty, he or she would only have $30,000 of a $50,000 account balance
to use. [$50,000 times 40 percent (30 percent regular and 10 percent additional taxes) = $20,000 in taxes; leaving only $30,000 for the new business.]

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