Financing a C-Corporation with a 401(k)
If you’re a small business owner who is looking into ways to finance your company, you might’ve looked into using a Rollover for Business Startups, or ROBS. With ROBS, you can use funds from your 401(k) for your startup without incurring any penalties.
If you’d like to use funds from a 401(k) to finance your startup, you’ll need to first set up a C-Corporation. That’s because you’ll need to establish a retirement account from your business in order to tap into your retirement funds. And before structuring your business as a C-Corp, you’ll also want to keep in mind the ins and outs that will be involved.
In this primer, we’ll go over how to set up a C-Corporation so you can then tap into a retirement account to provide capital for your business. According to FitSmallBusiness.com, here’s how you can go about financing a C-Corporation with a retirement account.
What Is ROBS?
As the name implies, ROBS is a rollover of funds from your retirement fund for your small business. If you’re under 59 ½ years old, you’ll be subject to paying a 10 percent penalty for taking out an early withdrawal from a retirement fund such as a 401(k). But if you’re using ROBS to finance your business, you won’t have to pay early withdrawal penalties or taxes.
Another perk is that with a ROBS, your 401(k) owns actual shares of your small business. So when your business makes a profit, a portion of these profits goes back to your retirement account. Here’s how to set up your small business correctly so you can use a 401(k) to finance your venture.
1. Set up a C-Corporation
First, you’ll need to set up your small business as a C-Corporation. A C-Corporation is generally for larger businesses, and it is formed by filing Articles of Incorporation with the Secretary of State in the state in which you want to incorporate your business. One of the main benefits of structuring your business as a C-Corporation is that it’s relatively easy to access funding through issuing stock.
Note that you won’t be able to use money from your retirement account if your business is structured as an LLC, LLP, S-Corp, or sole proprietorship.That’s because a C-Corp can complete certain transactions dealing with qualifying employer securities that other types of businesses can’t.
2. Select a Retirement Plan
You’ll then need to create an employee-sponsored retirement plan. Some examples include:
- 401(k) retirement plan
- Profit-sharing plan: You designate a percentage of your annual profits into a pool of funds. This pool of funds is then shared with your employees or among certain employees, such as executives or exempt employees.
- Defined benefits plan: Otherwise known as a pension plan, a defined benefits plan can either be a lump sum paid upon the start of retirement or a monthly pension payment plan.
- Defined contribution plan: This is a plan where the employer sets aside a percentage of money each year for its employees. Examples of a defined contribution plan include a 401(k) or a SIMPLE IRA.
- A mix of plans: You can set up a retirement plan so that it includes a combination of any of the above.
3. Transfer Funds to Your Company Retirement Account
Here comes the rollover part. Next, you’ll want to move funds from your personal retirement account to your company’s new retirement account.
4. Your Company Retirement Plan Buys Stock in Your Company
You’ll then buy stock in your company using funds from your retirement plan. After you buy stock in your company using funds from your retirement plan, your C-Corporation now has access to financing to launch or grow your business.
5. Consult an Expert
While there are obvious perks to setting up a C-Corp so you can use a retirement account such as a 401(k) to finance your business, there are a lot of ins and outs that come with ROBS. In other words, it’s complicated.
For instance, there are obviously added administrative tasks and paperwork that come with using ROBS, plus requirements outlined by the IRS and Department of Labor (DOL). Plus, you’ll need to carefully follow all the rules and regulations to avoid incurring hefty fines.
“Rely on the experts that help you engage in this strategy for advice, guidance and to keep you out of trouble,” says Kirsten Curry, attorney at law and president of Leading Retirement Solutions, a nationwide 401(k) provider. “The ROBS strategy is a very complex one, highly regulated and has really unique rules. Clients should not be doing it alone when it comes to this strategy.”
If you have questions about setting up a C-Corporation so you can fund your company using a retirement plan, Incfile can walk you through the process of starting your company. You can talk to one of our experts today.