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Investor Insights Blog|ROBS vs. Self-Directed IRA for Business Funding: What’s the Difference?

Small Business Plans

ROBS vs. Self-Directed IRA for Business Funding: What’s the Difference?

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If you’re looking to start or purchase a business, you may be considering using your retirement account as a funding option.

There are different ways to tap a retirement account for business capital, each with its own benefits and drawbacks. Two of the more well-known options are:

  • Rollovers as a Business Startup (ROBS): Rolling over a retirement account, forming and investing in a C-Corporation, purchasing stock from the corporation, and using the funds to pay for business costs
  • Self-directed IRA: Investing in a business – directly or through a Limited Liability Corporation (LLC) – using a retirement account held by a self-directed account custodian

If you’re considering these business funding methods, which one is best for you? Should you set up a ROBS, or would it make sense for you to open a self-directed account for business capital?

The chart below outlines the difference between funding a business with a ROBS vs. funding with a self-directed IRA, how each strategy works, and the pros and cons of each. Before you decide, it’s important to work with the appropriate tax and/or legal professional and understand the potential tax implications.

ROBS vs. Self Directed IRA Comparison

Summary

ROBS

Rollovers as a Business Startup (ROBS) Plan is an employer-sponsored program that enables business owners to roll over an existing retirement account into a qualified retirement plan (QRP) or ROBS 401(k) to pay for startup or existing business expenses.

The person starting the business would buy stock in the company (Corporation) and use the sale proceeds for business costs.

ROBS plans are generally used when investors have no other choice but to use their retirement account to start a business venture in which they will be involved in the day-to-day operations.

What would otherwise be considered a prohibited transaction in an IRA can be considered permissible under a ROBS plan. These plans require a specialized attorney and firm to properly structure and counsel the investor.

Self-Directed IRA

A self-directed Individual Retirement Account (IRA) enables investors to use their account to fund business startups and make other investments beyond the stock market.

Self-directed IRAs are intended to be used for investment purposes, to benefit long-term retirement goals.

How it works

ROBS

  1. A prospective business owner forms a C-Corporation
  2. A QRP or Solo 401(k) plan is opened (this requires the account holder to claim earned income); the account owner transfers funds from another retirement plan
  3. The QRP or Solo 401(k) purchases 100% of the shares of a corporation, often one the account holder owns and operates

Self-Directed IRA

  1. An investor opens a self-directed IRA or other account with a self-directed custodian
  2. The investor directs the custodian to invest in the business
  3. The assets are held in the name of the self-directed account

Some custodians, such as Equity Trust, offer online tools and robust client services to facilitate simple, timely transactions.

Learn more about investing in a business with your retirement account.

Corporation status and taxes

ROBS

Due to the corporation structure, corporate tax applies, and income flows through as dividend income.

Discuss potential advantages and disadvantages with your CPA or tax professional.

Self-Directed IRA

Typically, no LLC or corporation is formed or required. This can potentially equate to lower maintenance and lower fees.

For example, an investor simply looking to buy and hold a rental property can do this directly through a self-directed account without the intervention of a ROBS plan and no corporate tax on the corporation side. The rental income flows to the IRA, tax-exempt.

Discuss potential advantages and disadvantages with your CPA or tax professional.

Pros

ROBS

With a ROBS, it is possible for investors to draw a salary or pay themselves. If an LLC is necessary, self-directed IRA LLCs are often easy to form and require lower costs and less maintenance compared to a ROBS.

Self-Directed IRA

No IRS Form 5500 is required.

Business gains are tax-deferred or tax-free.

Cons

ROBS

ROBS require a specialized tax-professional/legal professional to draft the necessary documents, complying with applicable retirement account guidelines and laws. This could potentially equate to higher fees.

Plan sponsors are required to file IRS Form 5500 each year.

Other potential pitfalls include depletion of retirement funds if a business fails, misunderstanding IRS form requirements, plan promoter fees, and more, according to the IRS.

Self-Directed IRA

Self-directed IRAs, 401(k)s, and other accounts are for investors seeking to diversify and grow their accounts for the long term. You cannot pay yourself from your IRA; this would be considered a prohibited transaction.

You cannot buy a business from yourself or other disqualified individuals in your self-directed retirement plan.

With both approaches, it’s important to be aware of the prohibited transaction rules for retirement accounts, and consult your CPA or financial professional before making a decision.

To learn more about how self-directed IRAs can be used to fund a business, talk to a knowledgeable IRA Counselor.

small business account guides

 

1

Can my IRA invest in a newly formed entity that will invest in real estate?

Yes. Investments in newly formed private entities, such as limited partnerships, limited liability companies, C corporations or land trusts, are permissible under the Internal Revenue Code, with the exceptions of subchapter S corporations.

2

What are prohibited transactions in an IRA?

According to the IRS, a prohibited transaction is improper use of an IRA account or annuity by the IRA owner, his or her beneficiary or any disqualified person. Examples of prohibited transactions with an IRA are borrowing money from it, selling property to it, using it as security for a loan and buying property for personal use (present or future) with IRA funds.

Video: Solo 401(k) Pros and Cons

 


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