Downsides to the ROBS Funding Strategy

Investing your retirement funds into your own business provides several key advantages or upsides which I will cover next week. This week we'll cover the risks, the downsides to adopting a ROBS strategy. This 2013 article on the SBA website also mentions downsides, and contrasts a ROBS setup with using an IRA for the same purpose

ROBS Downsides

This is my take on the three downsides mentioned in the 2013 article plus one additional one based on client stories.

Putting retirement savings at risk – A true ROBS downside. I have many clients who firmly believe that investing funds into a business they control is less risky than leaving the funds in a mutual funds controlled by someone else. Most retirement accounts lost 45% of their value in 2008. Still, some of my clients have lost their entire retirement savings when their business failed. It happens. I also know that, because they are putting their retirement savings at risk, ROBS clients are more inclined to invest into businesses they understand and have a better chance for success.

Increased IRS scrutiny – 401K Plans are monitored for compliance by the DOL and the IRS. The DOL focuses on the employment rights issues whereas the IRS enforces tax compliance.  Plans invested into their sponsoring corporation have additional reporting requirements for the qualified employer stock that do not exist for plans without this stock. Does sponsoring a 401K plan with QES stock invite additional IRS scrutiny for corporation? With over 1,500 clients in 15 years, I have rarely seen the ROBS strategy result in increased scrutiny. The key is to use a good plan admin to get the 5500 done right and on time, extend plan benefits to all eligible employees, and properly value plan assets.

Costs – ROBS promotion companies charge about $5k to set up a ROBS arrangement, and an additional $1k per year to administer the plan. I charge a similar flat fee to create a ROBS arrangement which includes the state filing fee, all phone calls and emails, and the plan setup fee. I also work with a superb plan trustee that creates and administers the plan for about the same annual cost. Yes, the cost of setting up and mantaining a ROBS arrangement is a factor to consider.

Plan Administration – Several calls to my office start with "If I knew how much of a headache it is to have a 401k plan..." People do not get into business for themselves to become plan trustees and administrators. Unforatunely, the record keeping services offered by the most ROBS promoters places significant reporitng responsibilities on the client's shoulders. It doesn't have to be that way. I suggest to people who call with this frusration that they use the plan admin I use. This tends to solve their frustrations. The ROBS setup is the easy part. Working with your plan admin lasts the life of your plan. Choose wisely.


Use an IRA Instead?

The author then mentions, “ROBS are not the only way to own stock in a company you control. You can use a self-directed IRA for this purpose.” The author describes a court case where the taxpayers involved invested funds into a company and then co-signed a loan, which disqualified their IRA. That court case is Peek and Fleck v. Commissioner. The IRS also argued in Peek that wages paid to them and rents paid to a company they controlled also constituted prohibited transactions but the court did not opine on those two arguments.

Does investing an IRA into the same business that one might create with a ROBS create a different risk for the retirement funds as an investment? No, same investment risk.

How about IRS scrutiny? Investing an IRA into your corporation, in my experience, greatly increases the risk of IRS scrutiny because of the potential for prohibited transactions (PT). The downside of a PT, as happened to Peek and Fleck, is a complete disqualification of the IRA,  retroactive to the PT date, with taxes, penalties and interest immediately due. A company one controls is treated as a disqualified person for prohibited transaction discussions when an IRA invests. However, the investment from a 401K plan into stock of the sponsoring employer is exemtped from prohibited transaction rules. You may be on the board of directors and an officer. You are also required to be an employee of the corporaiton and may be paid for your labor. Very different result.

The cost of a self-directed IRA is less than a ROBS. At Frank Selden Law you will save $3,000 to create a SDRIA rather than a ROBS. Do NOT invest your IRA into a company you control just to save $3,000 in the setup. An IRS determination that you created a prohibited transaction could cost you 60-70% of your qualified funds in taxes and penalties. Use an SDIRA for passive investments only. Use a ROBS for active businesses.


Get it Right

I am a fan of the SBA. I highly recommend their resources for writing your own business plan. The SBA does not create ROBS or SDIRAs. The SBA does offer financing for small businesses, including those funded with a ROBS strategy. The article recommends competent legal advice, and in this regard I fully agree. You can book your own no cost or obligation appointment here. Get it right, right from the start.

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