If you’re considering investing in a franchise and retirement planning is your goal, what you are really doing is called a Rollover as a Business Startup, known by the IRS as a ROBS plan. There are two ways to do this:
Company 401(k) – If the company you own offers a 401(k) program, you can invest the funds (employer and employee contributions) into a franchise business.
Individual 401(k) – You may choose to utilize your personal 401(k) funds to buy stock in the franchised business.
There are many caveats to both options and the IRS has strict guidelines on using a ROBS to invest in a startup business—even a franchise business.
How it Works
Basically both options allow 401(k) plans to form a separate entity (corporation) and use the retirement funds to purchase stock in a business startup. If a 401(k) plan is a company plan where the plan administrators determine investing in a startup via a ROBS plan is a good idea, the new entity must be a C Corporation considering all the contributors of the plan (employers/employees) in order to send out appropriate 1099-R forms to all contributors.
A 1099-R form, known as “distributions from pensions, annuities, retirement or profit-sharing plans, IRAs, and insurance contracts,” must be sent to everyone involved in the ROBS investment (shareholders). These first 1099-R forms sent to shareholders in the ROBS plan must show the initial investment of every shareholder based on percentage (retirement funds) invested. Initial investments shown through 1099-Rs mean investors gained something and, therefore, must submit the 1099-R with their personal tax returning showing such an investment which may be subjected to income tax.
Before any ROBS plan is created, the new entity must request a determination letter from the IRS; or in other words, the IRS must approve the ROBS plan prior to using the funds for investing in a franchise and retirement planning is the sole purpose.
Finally, the IRS requires Form 5500 (company retirement plan) or a 5500-EZ (personal retirement plan) be submitted annually.
While many ROBS plan offerings may be setup and approved by the IRS via a determination letter, many fail to file Form 5500 or 5500-EZ which causes red flags and red flags often mean unwanted IRS audits.
Items to Consider
Buying a franchise as a retirement planning tool may not be all it’s cracked up to be. Essentially the IRS still allows but frowns upon ROBS plans as they look at them as a way for retirement plan administrators or single 401(k) owners to invest and not pay the required income tax.
Further, the IRS reports most ROBS investments don’t do well and many are in non-profitable situations meaning investors look at this as a way to offset income with 1099-R losses from the business.
In addition, the owners of a pension plan may have some restrictions on what they can and can’t invest in, often meaning a startup franchise or a business area showing areas of failure or potential doom. These types of restrictions protect all the investors (employees) in the plan from losing contributions meaning the plan administrators may have to invest more to pay back 401(k) members on contributions and company matches—even promised returns on those investments.
ROBS plans must be approved and structured appropriately in order to stay in compliance and avoid IRS audits.
If you feel this is the right choice for your retirement planning or if you’re a plan administrator (owner of company 401(k) plan), it’s best to consult tax and legal professionals to guide you through the process and ensure required forms are distributed and filed.
Finally, some franchisors may not approve a ROBS plan as a way to invest so each franchisor must be contacted to ensure a ROBS plan is indeed allowed.
It’s best to review what the IRS has to offer on such plans (links below) to avoid penalties for breaking IRS rules—often these penalties are severe and according to the IRS can be as high as 110 percent of the initial investment.
Ask a personal finance advisor or other professional to help you make the determination if this type of retirement choice to invest in a franchise or any other startup business is an avenue for your pension plan or if it’s something to skip altogether.
IRS – ROBS – 2010 – https://www.irs.gov/retirement/article/0,,id=231594,00.html
IRS Determination Letters – https://www.irs.gov/retirement/article/0,,id=218539,00.html
IRS – Form 5500 – https://www.irs.gov/pub/irs-pdf/f5500.pdf
Accountants CPA Hartford – Rollovers for Business Startups – https://www.cpa-connecticut.com/robs.html
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