Paul L. Caron

Wednesday, October 31, 2012

Davidoff: The Risks of Using Retirement Funds to Start a Business

NY Times DealBookNew York Times DealBook  The Risks of Tapping Your Retirement Fund for an Alternative Use, by Steven M. Davidoff (Ohio State):

Retirement funds are being used increasingly for anything but retirement. Instead, 401(k)’s and individual retirement accounts are becoming money pots used to invest in business start-ups, speculate in gold and buy private equity investments.

Such maneuvers come with big tax advantages. But they may also leave their users penniless in retirement, while their ability to evade taxes can cost the government. ...

IRAs and 401(k)s were never meant to be used to start a business. ... The strategies to do so and not run afoul of IRS regulations are varied, but the main one is to start a business and have it adopt a 401(k) plan. The existing 401(k) plan is rolled into the new one, which is invested in the new business. Voilà -- instant financing. The downside, however, is that there is no money for retirement if the business fails.

And there is evidence that most of these businesses do fail. The Internal Revenue Service terms one form of this scheme as a Rollovers as Business Start-Ups plan, or perhaps with some unintended irony, a ROBS plan. In 2009, the IRS studied ROBS plans and found that most of these businesses had gone bankrupt, losing the person’s retirement savings. In most cases the money was lost before the business even got off the ground. Nonetheless, the I.R.S. does not prohibit ROBS plans, but it has called for more scrutiny of the structure.

(Hat Tip: Mike Talbert.)

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