As a self-directed IRA facilitator, we have been receiving higher than usual inquiries regarding the use of IRA funds to fund a new business. This type of transaction is referred to as “rollovers as business start-ups” or ROBS by the IRS and by others as 401k small business financing because it allows the entrepreneur to finance her new business with IRA funds without having to pay taxes and penalties generally applicable to IRAs. The individual rolls over her IRA into a newly formed 401(k) plan that is adopted by the new business and subsequently invests these rollover funds in stock of this new C-Corporation.
Funding a business with IRA funds generally entails the following steps:
- The individual forms a new C-Corporation;
- The C-Corporation sponsors a 401k plan that permits investing in employer stock;
- The individual adopts the 401k plan and then transfers or processes a rollover of her IRA into her newly opened 401k plan;
- The individual then self-directs her 401k plan to purchase the C-Corporation’s issued stock; and
- The C-Corporation uses the IRA rollover proceeds from the stock transaction to purchase an existing business or to start a new venture.
The use of IRA funds to finance a business via a rollover to a 401k plan is governed by ERISA Section 408(e)
ERISA Section 408 ( e ) states that the prohibited transaction rules do not apply to a plan’s purchase or sale of qualifying employer securities (stock), defined in ERISA Section 407(d)(5) provided the following is satisfied:
- The acquisition or sale is for adequate consideration,
- No commission is charged, and
- The plan is an eligible individual account plan as defined in ERISA Section 407(d)(3).
While the use of IRA funds to fund a business may seem straightforward, the ROBS rules can easily be misconstrued, resulting in taxes and distribution penalties if the rules are not carefully followed. As such it is recommended that you work with both a 401k professional and an attorney when using your IRA funds to fund a business. The 401k professional will handle the facilitation of the paperwork and the attorney will handle the compliance matters.
If you are interested in finding out more about how to fund a business with IRA funds, contact us to schedule a free consultation with our Harvard Law-trained attorney.
Lastly, don’t confuse the self-directed Solo 401k with the ROBS transaction. The self-directed solo 401k is for investing in passive investments such as real estate, precious metals, tax liens and promissory notes, to name a few, while the ROBS or 401k small business financing arrangement as described above is for funding an operational business.