July 14, 2024


Taste For Business

How to roll over retirement savings to buy a business

Troy Heuermann’s career at 3M had come to an end last spring, but he wasn’t ready to retire. He wanted to own a small business.

Taking stock of his finances, he found the down payment he needed to achieve that lifelong dream in an atypical spot: his retirement account.

Using a Rollovers for Business Startups (ROBS) structure, Heuermann was able to buy ProFab Welding & Machine in Lakeville, which manufactures parts for a variety of other businesses.

“My retirement was already invested in companies, so why not invest in my own?” said Heuermann, 52. “I’m having a ball. I was originally thinking of retiring at age 58, but as long as this goes well I can see another 10, 15 years.”

A ROBS transaction is a little-known mechanism that allows retirement savings to be invested into a new or acquired business while deferring taxes and avoiding an early-withdrawal penalty.

The premise is simple, but it’s a complex process that requires several carefully orchestrated steps and a specialized provider to help complete.

“Individuals should consult with their banker, tax adviser and ROBS provider to understand the process and potential ramifications,” said Jeff Kinate, an SBA lending expert at Old National Bank. “Clients have commented that it is important to weigh the immediate ROBS benefits versus the future implications — along with the set-up process, which can take weeks.”

Because of the way the 401(k)-funded business must be structured, it’s not a perfect setup for everyone. Some lawyers even advised Heuermann against it.

“I have a pension, which gave me some flexibility,” he said. “Rather than tie up individual assets in the corporation, this was a diversification of my retirement money.”

While ROBS has been in use since 1974, it remains under the radar.

“It’s certainly an eye-opener for a lot of buyers I talk to,” said Jon Tichich, a business broker at Sunbelt Business Advisors in Minneapolis. “For businesses we sell that are acquired by individuals, I’d venture about a quarter are using a ROBS rollover.”

Investing retirement funds in a growing business or successful startup could mean a better return than what the stock market can offer — or it can wipe out that nest egg in a way that won’t happen to most traditional retirement accounts.

“For me specifically it was a good option,” Heuermann said. “I don’t know that it would be for everyone.”

How does it work?

Whether starting a new business or acquiring one, ROBS rules require the formation of a new C corporation.

That C-corp then establishes its own retirement plan, typically a 401(k), where money from an existing account is rolled over. Those funds are used to buy stock in the corporation, and the money is then available for the business to spend.

In the case of a business acquisition, this new C-corp buys the assets of the acquired firm.

The owner must be an active employee who is paid a salary — it’s not a passive investment — and the company has to focus on selling goods or providing services.

All employees must be offered the chance to buy into the retirement plan that owns the company.

What are some of the benefits?

The biggest benefit comes from having the capital to invest in a business without having to take out a loan — or having cash to complement a business loan.

Heuermann said he’s happy to actively manage his investment and has been relishing the thrills of running a small business.

“I’m enjoying doing meaningful things in my career that make a difference,” he said. “I no longer make spreadsheets for someone else. I make decisions every day that affect 20 people.”

What are some of the drawbacks and risks?

Because the business is required to be structured as a C corporation, the business is taxed on its earnings and its shareholders pay personal income taxes on dividends paid out (an S-corp is taxed just once).

Keeping the company in compliance with IRS rules also requires ongoing payments to ROBS providers like Guidant or Benetrends, which handle annual reporting and other technicalities.

Selling the business — or having to deal with insolvency — can also be as complex as setting it up, given the fact it is owned by a retirement plan.

Then there is the simple risk of losing money that could otherwise be offering steady returns when invested in the stock market long term.

“There’s a potential risk, but life is full of those,” Heuermann said.