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ROBS vs. Self-Directed IRA: Which is Right for Your Business?

When it comes to funding options for your small business, there are many options. For many entrepreneurs, the best option can be found in their 401(k)/IRA.

Using retirement fund assets as your primary financing source has several advantages, like not being subject to loan repayments or taking on additional debt. Yet those advantages depend on choosing the right approach to financing your new company.  If you do an internet search on 401(k)/IRA business funding, you will see two prominent options -- using a Rollover as Business Start-Ups (ROBS) strategy or a self-directed IRA.

While both are legitimate and legal options, they are, in many ways, polar opposites. Understanding these differences is important. Both ROBS and self-directed IRAs allow for funding of a business and provide tax benefits. That is really where the similarities end. 

So, what are the differences between a ROBS and a Self-Directed IRA funding strategy?

ROBS Funding vs. Self-Directed IRAs

A ROBS funding strategy allows you to invest your 401(k) to start or recapitalize a business without incurring early withdrawal or tax penalties. It is a simple 4-step process. Making use of this regulation requires four primary steps:

    1. Establish your business as a new C Corp for tax purposes. This allows you to make use of your 401(k) funding by buying stock in the newly created corporation.
    2. Set up a qualified retirement plan for the new corporation.
    3. Roll your 401(k) funding into the new retirement plan.
    4. Invest the funds from the retirement plan and into the business.

While the process for using a self-directed IRA also involves a 4-step process, they are vastly different from a ROBS:

    1. Find a financial advisor to set up a self-directed IRA. Under the law, you must have an independent trustee to manage this account.
    2. Rollover your existing IRA, 401(k) funding, or 403(b) account to the self-directed IRA.
    3. Instruct your trustee to set your business up as a Limited Liability Company, or LLC. The LLC must be managed by the owner of the IRA.
    4. Once the LLC is set up, you can direct the financial advisor to make the purchase, transfer the funds, and maintain the legal paperwork.

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Self-Directed IRA Limitations 

If you want to invest in someone else’s business, then a self-directed IRA might be a good investment choice. However, if you are going to work for the business, a self-directed IRA is off the table. 

Self-directed IRAs are intended to be passive investment vehicles, with no direct involvement in running the business. The IRA owner cannot have any active involvement in the business and cannot receive any salary from a business in which it invests. 

There are other limitations when using a self-directed IRA approach. For example, the IRA owner cannot personally guarantee a business loan. 

The IRA, if established as a C corporation, may issue stock ownership shares. However, the owner of the IRA may not receive shares.  

Differences with ROBS Funding 

Those restrictions with self-directed IRAs are a stark contrast to the way ROBS funding is structured. 

With ROBS funding, the owner can be actively involved with the business and can receive compensation from the newly established corporation for services provided. The owner can personally guarantee a business loan. 

Another major consideration is if mistakes are made. In both cases, prohibited transactions may subject the owner to various penalties. However, with a ROBS approach, the retirement plan can retain its tax-deferred status. With a self-directed IRA, if there is a prohibited transaction, the IRA loses its tax-deferred status, retroactive to the year the note was guaranteed. 

A ROBS funding strategy is a smart option for small businesses. Benetrends was the first to introduce this type of funding and for over three decades has helped thousands of business owners use their retirement funds to fuel the launch and expansion of successful companies. To learn more, download The Definitive Guide To 401(k)/ROBS Business Funding

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