Can I Use My 401(k) to Buy a Franchise?

Can I use my 401(k) to buy a franchise? You’ll hear a confident yes from people selling ROBS, short for Rollover as Business Startups. My answer is more careful. Some people do it. The IRS does not treat ROBS as an abusive tax avoidance transaction. The same IRS pages call these deals “questionable” and say they often go wrong. Here’s what that means before you touch retirement money.

What ROBS Is

According to the IRS, a ROBS arrangement lets a prospective owner use retirement funds for new business start-up costs. In the typical design the IRS describes:

1. You form a C corporation.

2. The corporation sponsors a new qualified retirement plan that can invest in employer stock.

3. You roll funds from a prior plan or IRA into that new plan.

4. The new plan buys stock in the C corporation.

5. The corporation uses that cash to fund the business, often a franchise.

The structure is meant to move retirement money into the business without a taxable distribution at that step. Whether your deal stays compliant depends on how it’s set up and how it’s run. I am not a tax lawyer, and this is not tax advice.

What the IRS Actually Says

ROBS plans are “not considered an abusive tax avoidance transaction,” but they are “questionable” because they may solely benefit the one person who rolls over the money. Promoters “aggressively market” them. Many companies seek an IRS determination letter so clients feel the IRS approved the arrangement. The IRS says a determination letter only means the plan’s written terms meet Code requirements. It does not protect you if you operate the plan incorrectly or in a discriminatory way. Disqualification can bring adverse tax consequences for the sponsor and participants.

The IRS also notes that franchises are often the business of choice for ROBS customers.

Where ROBS Plans Get Into Trouble

From the IRS ROBS project and its guidelines, common problem areas include:

  • Amending the plan after the stock purchase so other employees can’t buy employer stock
  • Coverage and nondiscrimination issues
  • Questionable valuations of the new company’s stock
  • Promoter fees
  • Failure to issue Form 1099-R on the rollover
  • Failure to file required Form 5500 returns (the IRS says the one-participant filing exception does not apply the way some promoters claim)

The IRS project also found that, while there were some success stories, most ROBS businesses either failed or were heading that way, with high rates of bankruptcy, liens and dissolutions. Some people lost both years of retirement savings and the business. In some cases, much of the money was gone before the doors opened.

This Is Not a Simple Withdrawal

A plain early 401(k) withdrawal is different. The SBA warns that tapping retirement accounts early can bring fees, penalties and damage to your retirement timeline, and it tells people to check with the plan administrator and a financial advisor first. ROBS is marketed as a way around that taxable path. That only helps if the structure stays qualified.

Before You Consider It

Let’s Talk Before You Touch Retirement Money

If someone has pitched you a ROBS deal and you want a second opinion on the bigger picture, I’m glad to talk. I won’t pretend to be your tax counsel. I will help you think clearly about the risk. Call me, John Henning, at 267-417-4980.

Sources

  • IRS, Rollovers as business start-ups compliance project: https://www.irs.gov/retirement-plans/rollovers-as-business-start-ups-compliance-project
  • IRS, Guidelines regarding rollover as business start-ups (PDF, Oct. 1, 2008): https://www.irs.gov/pub/irs-tege/robs_guidelines.pdf
  • U.S. Small Business Administration, Buy an existing business or franchise (self-funding / retirement account caution): https://www.sba.gov/business-guide/plan-your-business/buy-existing-business-or-franchise