ROBS Downsides | Frank Selden Law

ROBS Downsides

Investing your retirement funds into your own business provides several key advantages or upsides which I will in the next post. This post covers the risks, the downsides to adopting a ROBS strategy. The downsides can be mitigated by the way your ROBS setup is created. 

ROBS Downsides

Putting retirement savings at risk – I have many clients who firmly believe that investing funds into a business they control is less risky than leaving the funds in 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 in 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 in 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 the 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 maintaining a ROBS arrangement is a factor.

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. Unfortunately, the record-keeping services offered by most ROBS promoters place significant reporting responsibilities on the client's shoulders. It doesn't have to be that way. I suggest to people who call with this frustration 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.

Use an IRA Instead?

Can you reduce your risk by using an IRA rather than a 401k plan? No. In fact, using an IRA exposes you to prohibited transaction regulations. Consider the court case Peek and Fleck v. Commissioner. The IRS argued in Peek that guaranteeing a loan to the company, wages paid to Peek and Fleck, and rents paid to a company they controlled constituted prohibited transactions, all of which would be allowed in a proper ROBS setup. 

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, the 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 the stock of the sponsoring employer is exempted 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 corporation and may be paid for your labor. Very different result.

The cost of a self-directed IRA is less than a ROBS. Do NOT invest your IRA into a company you control just to save a few thousand dollars 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

You can book your own no cost or obligation appointment here. Get it right, right from the start. Know the differences between a ROBS strategy and an IRA investment. Then choose wisely. 

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