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How to Use Tax-Deferred Savings to Fund Your Start-up

My friend Shelton has decided it’s time to start his own business.

Mike Detmer ([email protected])
is the principal of Detmer Business Solutions, which provides companies in the systems integration space with easy-to-use business knowhow modules that enable functional managers to better execute key duties.
My friend Shelton has decided it’s time to start his own business. After working for a firm in the southern part of the state over the past decade he’s certain that now is the time to relocate. Ultimately he wants to be closer to his retired parents, so his kids can see their grandparents more often, and he can provide assistance as they age. But in Shelton’s line of work, he’s going to have to start his own business to secure a steady stream of income. While he’s confident that his new business venture will fly, he’s not willing to go into debt to fund it.

Wisely, Shelton has been contributing to a 401(k)-deferred contribution plan during his career and his savings have grown into a sizable amount. Certainly there is enough to provide him with the money he plans to spend opening his own business. Moreover, Shelton’s business plan shows his new business venture breaking even in just over a year. He feels confident that putting his savings to work in a new business will likely outpace its growth compared to where he currently has it invested in stocks and bonds. The only problem is that if Shelton touches his 401(k) funds, he may have to pay a hefty price in early distribution taxes and penalties.

Fortunately, there may be a solution that allows Shelton to use the money out of his 401(k). By employing a rather esoteric business procedure, Shelton could fund his new business with money from his 401(k) account without paying penalties or taxes. This procedure is referred to as a rollover as business startup (ROBS) and is beginning to gain popularity among middle-aged entrepreneurs who have ample tax-deferred savings that they want to access to start their own businesses. And like in any market, as the popularity of ROBS has grown, there have been more financial institutions coming available who specialize in ROBS capitalization and serving customers who want to use them.

Now before you think this is too good to be true, put on your thinking cap and assess the risks, i.e., if your business goes south, so do your savings. That’s why before making any moves you should seek the advice of a professional financial planner and look at several institutions to see who offers the most comprehensive ROBS services and for what fee. Typically there is an up-front flat fee paid to the financial institution, as well as an annual fee for continuing service if required. To find an institution in your area, try Google searching “rollover business startup” or ROBs financing or talk to your accountant.

As the home building market rebounds, those who feel confident in starting their own businesses or who have business expansion plans may want to explore the rollover as business startup (ROBS) option.While each institution offering ROBS services may have different steps and value-adds, they all do pretty much the same general procedures of: 1.) Forming a C corporation for you or working with your attorney to do so, 2.) Establishing a 401(k) plan for your new corporation (which may be an advantage in attracting talent as your business grows), 3.) Rollover your existing 401(k) or IRA funds into your new corporation’s plan, 4.) Have your new corporation’s plan purchase stock in your corporation, which leaves the new corporation with cash in hand to invest in its start-up or expansion costs.

Now here’s where I have to emphasize that I am not a financial advisor, attorney, or accountant and not qualified to give you financial, legal or tax advice. My intent in writing this article is to merely make you aware of the rollover as business startup (ROBS) concept. As the home building market rebounds, those of you who feel confident in starting your own businesses or those of you with business expansion plans may want to explore the ROBS option to do so. Just be sure you secure the proper legal and tax advice so you don’t run into issues with the IRS down the road.