BACKGROUND: A friend of mine used his former employer 401k for funding his restaurant business earlier this year and I’m considering using my 401k for business financing as well. However, I’m used to just investing my 401k in a mutual funds not a business.
QUESTION: Can you please tell me in layman’s terms how I can use my existing 401k for business financing a restaurant start-up?
Thank you so much in advance,
Tom W. in Colorado
ANSWER: What you are describing is referred by the IRS as Rollover as Business Start-Ups (ROBS) and it involves using one’s retirement funds such as a former employer 401k for financing/funding one’s business such as a restaurant. Most operational businesses qualify while passive income generating businesses do not.
In layman’s terms, the basic 401k business funding arrangement works as follows:
A new C-Corporation is formed (in order for the ROBS 401k financing arrangement to work the entity type must be a C-Corporation)
The C-Corporation adopts a 401k (sponsors a 401k)
Retirement funds such as a former employer 401k are transferred/directly rolled over to the new 401k
The newly adopted 401k uses the new 401k proceeds transferred from the former employer 401k to purchase stock shares in the new C-Corporation.
The C-Corporation subsequently uses the proceeds to purchase or start a new business.