ROBS vs Self-Directed IRA

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Welcome everybody to the Directed IRA podcast.
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My name is Mark Coller.
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I'm here with the amazing Matt Sorensen.
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An exciting topic today because I always learn something from Matt when we dive deep into an area that uh is a little controversial.
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Today we have got to talk about this rollover on business startups called the ROBS 401k.
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And we want to compare it to the self-directed IRA because it is getting messed up online, on AI, and with social media influencers.
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And I'm building way too many questions of people who are getting this wrong.
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So we want to break down this Rob's strategy.
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What is it?
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Who should be using it?
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And then compare it to the self-directed IRA strategy.
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And again, what is it and who should be using that strategy?
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Yeah, and um, I think what many of you that are our listeners here already have a pretty good feel for the directed IRA concept.
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Um, so we're gonna start with Robbs, but I know we have always new listeners that are probably a Robbs fan.
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And you're like, what the hell is this directed IRA option?
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I didn't know that was an option.
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So I don't know.
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We'll see how it goes, but we're gonna talk about Robbs first.
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Why would you do a ROBS?
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Or why is it sold?
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What is the purpose of it?
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Then we'll get into how you do it.
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And it and it's and I want to say right out of the gate, it's not illegal, it's not a IRS grutinized top 10 dirty, top 12, dirty dozen thing.
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They're just technical and there's they come with a good and a bag, a lot of good and bad, a lot of bad, you know, so you got to be careful there.
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So what the ROBS is is for someone that has maybe a little good an oversized 401k, I was gonna say a little nest egg in their retirement account.
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They worked for a large company for years, they've they've put away their money in their 401, and they're in their 50s, uh, maybe older, maybe a little younger, and they've got this money sitting in the 401k, and they're like, ugh, I want to use this to start a business, a business they want to run.
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So they want to go buy a job.
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Oh, did I say that?
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But they want to go buy a business.
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And they want to buy this business with the money in their 401k.
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And they think, oh, I should be able to do that.
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No, that's prohibited transaction to just buy a business with your 401k and start running it.
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But the Rob strategy creates a technique of where that 401k, that old 401k of yours, can buy a business or start a franchise or whatever, and you can work for the business.
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You're gonna follow a lot of rules along the way, but the theory is here, and why you might be interested in it, is it's not to invest the 401k creatively, it's to start or buy a business that you want to run.
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That's the Rob strategy in a nutshell.
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What do you Matt, did I summarize that well?
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Yeah, and we're at the cross section of this, of course, because we're working with clients every day using their IRA or 401ks to invest in private assets.
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You're buying real estate, investing in private companies, in small businesses, funds, crypto.
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I mean, we're knee deep in that every day at our company directed IRA.
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But also in our law firm, KQS Lawyers, we're advising clients, business owners, clients buying businesses, selling businesses, setting up businesses.
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And so we've we've been down the road on this many times.
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I've even set up about 30 different Rob structures for clients.
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Now I compare that to 25,000 accounts that we have at directed IRA.
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Okay, so that would give you the fit that I think where it works.
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Uh some little spoiler alert here.
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Yeah.
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So the thing that Matt I thought you were going to say, and I I want to finish the sentence for you in there, since we finished each other's sandwiches.
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Um, is uh that you said we set up every day 401ks and IRAs for people to buy businesses, but not businesses the owner of the IRA gets to work in.
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That's the big difference.
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Yes.
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And this is where the ROBs came about, is people are like, well, I can't use a self-directed IRA because I want to own the business 50% or more with my 401k, and I'm going to work in it and take a salary.
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And this is very popular in the franchise world.
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A lot of people are using this Rob structure to buy franchises, which can be great.
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Okay.
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And this again, I'm not like, you know, I've had clients do that.
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We've had clients just buy existing small businesses from people selling and exiting a business.
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And so what I would say is that it's very common as a funding mechanism to buy a franchise or an existing small business where you're going to be working in it, taking a salary, which you can't do with a self-directed IRA.
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There's a limitation that I'll cause a primitive transaction.
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Now, this loophole of the ROBs, and Mark said this earlier, comes with some baggage.
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Okay.
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So, yes, I can use that 401k I've built up over the years in corporate America, and I can get it into this Rob structure that buys a business that I'm working for and I'm taking a salary.
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But let me tell you what the big drawback is and then what this structure entails.
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Matt, I'd love that summary because that makes total sense as we explain it compared to the directed strategy, which we'll come to shortly.
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All right, so here's these steps, real quick.
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You have to set up a C corporation, C is in Charlie.
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You're not gonna be using an S corporation, which a typically a person would do if they're setting up a franchise.
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Then you're gonna take that corporation and form a new 401k.
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Then you've got to roll over your old 401k money that's probably sitting in an IRA now into that new corporate 401.
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Then that 401 is going to buy the shares issued from the C Corp.
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So now the 401 owns the same company that sponsored the 401.
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And there's a lot of technical terms in that process, but anyway, this 401k now owns the C Corp, and that C Corp hires you to go run the business and make it happen.
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And you get a salary, which has to be reasonable.
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And gosh, from there, Matt, that's when the surprises really happen for people.
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Am I missing a step that you'd add to that too?
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Yeah, and I say the keep in mind here the 401k, what it's doing is this is your account in the 401.
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So just like you know, you had your 401k at your job at Microsoft and you had your account in the 401k plan.
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I mean, this is your personal account in this new C Corp 401k that you just set up, you know, Vandalay Industries, all right, whatever you want to call it, all right.
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But it's your Art Vandalay and you have your account in the Vandalay Industries 401k.
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Your account is gonna buy the shares of the C Corp and if your 401k account owns the C Corp.
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You don't own the C Corp, 401k does.
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What does that mean, Matt?
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Well, that means like, you know, the the income and profits are gonna build up in your 401k.
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This is an important point here.
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You can only take a salary that's reasonable.
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Let's say that this company starts doing amazing and you're making a million bucks a year.
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Maybe you can justify a couple hundred grand in salary that you're paying yourself and then the other 800 grand is gonna go down into your 401k.
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You're gonna pay corporate tax on it because you're in a C Corp at 21 percent.
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Now it's gonna go into your 401k no tax.
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But if this is a traditional 401k, it's building up.
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It's gonna come out later at ordinary income rates, you know, and maybe you can draw this out later in retirement.
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But what's happening is that income that starts building up in your 401k, if this is traditional dollars, which is what I mostly see people using in the ROBs, is that creating this kind of ticking time bomb that you're gonna be drawing out later?
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Where if I just owned it personally in an S-corp structure, max rate is gonna be 37%, right?
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I don't have a corporate tax.
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It's gonna come out to me right now.
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And assuming you know you hit the highest bracket here at 600 grand or so.
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But it when you run the math, it's not the best tax outcome in the Rob structure.
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And there's a couple other problems and snags here.
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I just want to get in compliance on it.
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But but I just don't a lot of people are like, this is a great tax strategy.
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I'm like, is it is it?
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Now, if I my understanding is correct, you could use a Roth 401k to do it.
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You could.
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But but most people don't.
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And you and some of you may be like, well, why?
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Why wouldn't I just use my Roth?
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Because remember my example.
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You worked for this company for years and years, you did your contributions, the company did their match.
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Nine times out of ten, that's gonna be a traditional 401k.
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It's only been in the last few years you could have a Roth 401k feature.
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But this is gonna be a traditional 401k.
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So then you say, okay, I'm gonna do the ROB strategy.
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Oh, but I want to do it with Roth money.
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So now you've got to pay tax now out of personal funds to convert the 401k to Roth before you start the ROBs.
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Now, yes, it'd be nice if it was a Roth 401k.
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So down the road, when you sell the company or get out finally, it would be all those profits would be tax-free.
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But um we don't see people do that because it takes such a huge hit up front on that 401k money.
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You can't chunk at it like we normally teach.
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And so you just end up with this traditional 401k where you're pulling the money out later.
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Yeah.
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And yeah, and so I agree.
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Yeah, it's hard to make sense of it tax-wise.
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And I, if you're doing the Roth 401k, which you can do in the ROB structure here, I can like it a little bit more, definitely.
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Now it becomes a lot more tax efficient.
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All right.
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Because now I'm building up this tax-free bucket of this income coming out of this business, it's making money.
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Now let's say you're like, all right, Matt, I'm gonna be able to sell it now.
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I can sell this business for five million bucks.
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Okay, let's say that that that opportunity comes up.
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If you have the traditional 401k and now I'm selling the business, great.
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I'm selling the C Corp stock, right?
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And now it's going into my traditional 401k, that's gonna come out at ordinary income rates.
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It's not gonna come out at capital gain.
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I could have just paid capital gain trade of 20%.
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I'm trading it for 37% possibly, if I'm at the highest bracket, you know, as I'm pulling money out of retirement of this traditional 401k.
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Now, if it's the Roth, like Mark was countering earlier, where this can where I if you're doing ROBs and this business is gonna be successful putting out cash-flowing income or you're gonna sell it for profit, definitely love the Roth.
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But if it's the Roth, then of course the business sells, it goes into the 401k, you sell the stock.
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And then when you're distributing it out later at 59 and a half and you're living off of this income, it's coming out tax-free, which is better than paying capital gains tax.
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So just know as you're getting into it, the real tax outcomes here.
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I just think the traditional is not a better structure.
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I think you'd better, you'd be better off just owning it personally and not going through the gymnastics, in my opinion.
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Yeah, and I want to summarize it with this again, kind of uh public service announcement.
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When you hear someone on social media, watch them on social media or hear them on stage, whatever, and they're talking about, oh, there's this unique strategy, and you can buy a business and sell it tax-free, and and it's, you know, and they talk about your 401k only and they just hit the highlights.
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Gosh darn it, it sounds pretty freaking awesome.
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It does.
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It sounds sexy, I get it.
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Regrettably, they aren't giving you the details of that baggage that comes along with it.
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And so I I want to affirm they work, and a lot of people have done this, and it's they've done it successfully.
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But a lot of clients we talk to get into the maintenance of this, which Matt, I know you wanted to comment on too.
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Yes.
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They and they realize, oh my gosh, this thing is actually not as um flexible as a typical business owner's used to.
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This is not owned by you, it's owned by a 401k.
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The rules regarding your salary are stringent.
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You've got to do a C Corp tax return.
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You've got to do your 401k tax returns, probably an extensive 5,500.
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Yep.
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You've the maintenance on this is not fun.
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And clients go, wow, if I would have known about self-directing, I think I would have taken a different route.
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And so just do your research when someone's selling you on this.
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But Matt again, you you you wanted to comment, I know, on that maintenance.
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Yeah, I think it's way more complicated, especially compared to a self-directed IRA, because you are going to be spending maybe five grand a year in accounting and just reporting fees on that structure.
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Keep that 401k plan is a little complex because it's not just a regular 401k, by the way.
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It has an employee stock purchase plan option in it.
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It's got that, which is the way you're getting around this loophole where you can still work in the business, by the way.
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So it's it's a little, it's a complicated 401k.
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Um and and you need someone that really does this.
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So there are companies that really do this day by day.
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We don't do it anymore.
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When I said I set up 30 of them, I probably had of those 30 clients that I set up the ROS for, I'll bet 20 of them didn't like it.
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It was the most of the people that set that up were just like, uh, this, I wish I just would have done this personally.
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This was way too much gymnastics.
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I feel bottled up here on what I can and can't do and how I take the money out of the business, how much I can take as salary, versus which is not the most efficient way to get money out of your business, by the way, is salary.
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You're paying self-employment tax, all of it.
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The rest is going down to my 401k, and that's traditional with most of these people.
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It's got it's growing tax, deferred, great, but it's gonna come out at a high rate.
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I can't touch it now until I'm 59 and a half.
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It's just like it's a it's a little clunky.
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Now, there are people that it can work for, and I want to say it's legitimate.
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And and and if you're like, this is how I'm gonna buy this business, this is the only funding way to get there, and I need to work in the business, um, I get it.
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I can see it being a use case, but don't think it's a great tax strategy.
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I would use it more because it's the way I can make this thing happen and pull off this deal that I want to do.
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Yeah, no, it's an excellent point.
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Well, I want to try to provide the transition here with a couple thoughts.
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If you're if you're listening to this podcast, watching us on um YouTube, you're there's a good chance you're looking at buying a business or starting a business from scratch.
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Please get over to our Main Street Business podcast.
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Uh, we've done uh several shows in the last year on due diligence and buying a business, when to buy a business, how to buy a business, and having your eyes wide open to that experience.
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The ROBs is a piece of this.
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There's a lot to consider if you're buying a business.
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So please get over there.
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And are we saying you can't have your 401k buy a business?
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No, your 401k can buy a business.
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Let's transition to that.
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I would love to self-direct and have my 41k buy a business.
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Okay.
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We've just got some prohibited transaction rules about you personally working in the business.
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And you might go, that sounds great.
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I didn't want to work in the business anyway.
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Okay.
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Well, now we're to the right time.
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Yeah, and I think let's hit a couple of things here because Mark and I have done some episodes on this about how to buy a business with your IRA or 401k.
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And the ROMS is like one of a few strategies here that's probably the least likely one that we see used.
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So if you're like, all right, guys, what can I do?
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Let me go through the first one that's actually the easiest.
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It's not even a self-directed IRA.
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It's just establishing a new S Corp for the new business, adopting a solo 401k, rolling over your IRA or 401k dollars, and taking a loan of 50K.
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So you can have a 401k where you can lend yourself half the balance of the 401k not to exceed 50 grand.
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You got 200 grand in a 401k.
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You can take out 50 grand that you loan to yourself that you can use to buy the business.
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The other 150 goes and stays invest in your 401k.
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But I can access 50K for any purpose.
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I can pay down high interest credit cards, but of course, here for our purposes now, you can use it to buy the business.
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You pay that loan back over five years.
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The interest you're paying back to your own 401k, by the way, is tax deductible because it was used for business purpose here.
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So we can so we can um use IRA 401k dollars to help you just buy it personally and just use the regular S-Corp and at least get 50K.
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And to juxtapose that to the self-directed format, the steps are so much they're so much easier and fewer.
00:17:10.480 --> 00:17:22.079
Uh you're rolling over that same old 401k that's now in an IRA somewhere from that job, and you know that you can invest it somewhere more uh wisely.
00:17:22.319 --> 00:17:25.200
So you open an account at directed IRA.
00:17:25.440 --> 00:17:31.839
Uh it could be a traditional, a Roth, or a combination of the two of them, and you roll that money in.
00:17:31.920 --> 00:17:38.720
There's no penalties, there's no taxes, and you start thinking about my options and your options.
00:17:38.799 --> 00:17:45.359
And you can say, well, I'm gonna start converting some of it to a Roth, or I would like to invest in a new startup.
00:17:45.680 --> 00:17:57.680
And your retirement account will be buying uh shares in an LLC, or maybe forming an LLC to go do a real estate deal or some type of business.
00:17:57.920 --> 00:18:12.640
And as long as you realize you're not gonna be running the day-to-day operations in the business, but able to make decisions regarding the investment and the overall oversight of the project, you find out that that's where you wanted to be anyway.
00:18:13.039 --> 00:18:21.119
And the tax benefits can be significant because you're not dealing with the C Corp in the middle and a salary and all those moving parts.
00:18:21.440 --> 00:18:29.839
Yeah, and I think the self-directed IRA, like if you're thinking of funding the business, and you're especially if you're not gonna work in it, that's the easiest.
00:18:30.079 --> 00:18:34.160
Just have, I would do a Roth IRA, particularly if you think this business is gonna be great.
00:18:34.480 --> 00:18:36.160
Let it own a share of the company.
00:18:36.319 --> 00:18:39.039
This could be an LLC, typically, is what it would need to be here.
00:18:39.200 --> 00:18:41.759
It could be a C Corp too, if that's you know, whatever.
00:18:41.920 --> 00:18:46.240
But but it the Roth IRA is gonna own the company or your share here.
00:18:46.400 --> 00:18:51.920
Maybe you own a third of it or you own 40% or one-tenth, whatever, you know, in the situation here.
00:18:52.079 --> 00:18:58.799
And there's someone else who's more the work partner that's gonna put in the work and the sweat equity and and maybe they're putting in some cash too.
00:18:58.960 --> 00:19:05.920
But but if you're not working in it and you're uh you're like the cash investor, this is where I love your IRA to come in.
00:19:06.160 --> 00:19:09.279
And that's what we see a lot of times with clients at directed IRA.
00:19:09.359 --> 00:19:10.880
They're investing in small businesses.
00:19:11.039 --> 00:19:15.200
And this is what you've, you know, you've heard in the headlines is like, this is what Peter Till did.
00:19:15.359 --> 00:19:19.200
I've seen so much of this influencer stuff out there saying, oh, Peter Till did the ROBs.
00:19:19.279 --> 00:19:20.079
No, he didn't.
00:19:20.240 --> 00:19:22.079
He did a self-directed IRA.
00:19:22.480 --> 00:19:27.920
He was like one of six different founders in PayPal, and that's how he invested his IRA in there.
00:19:28.000 --> 00:19:29.519
He didn't own 50% or more.
00:19:29.680 --> 00:19:36.000
His IRA was early, so it got in a very low discounted price when who knew if PayPal would even work, right?
00:19:36.160 --> 00:19:37.680
But his Roth IRA owned it.
00:19:37.759 --> 00:19:40.960
And, you know, he has this six billion dollar Roth IRA now.
00:19:41.119 --> 00:19:47.039
But there was other people involved where he didn't have control, and so it didn't cause this prohibited transaction issue.
00:19:47.200 --> 00:19:50.400
So there's nuances here on how you structure this.
00:19:50.559 --> 00:20:03.519
And I'll just say if you're planning to use an IRA to invest in a business where you're gonna work, you need to get an attorney, tax attorney, CPA, someone that's knowledgeable on these rules, helping you.
00:20:03.680 --> 00:20:08.880
Our lawyers at KQS lawyers help advise clients on how to structure this using their Roth IRA.
00:20:09.039 --> 00:20:11.119
What's the right LLC or entity structure?
00:20:11.279 --> 00:20:12.880
Can I work in the business or not?
00:20:13.119 --> 00:20:18.240
If, you know, and and and that's a little more nuanced, comp complex thing as well.
00:20:18.400 --> 00:20:23.519
If you want to keep it simple, though, it's just like invest your IRA in small businesses and just don't work in it.
00:20:23.759 --> 00:20:26.400
I don't care what percent you own or what, it doesn't matter.
00:20:26.559 --> 00:20:32.240
You can own 100%, you could own 1%, just don't work in it and it doesn't cause an issue.
00:20:32.480 --> 00:20:46.720
It's where you're physically working, providing services, taking a salary, where your IRA is invested, it causes a problem, which is where this ROB structure came from, because it solved that limited issue of you want to work in the business and take a salary.
00:20:46.880 --> 00:20:48.559
That's where you need to go, Robbs.
00:20:48.720 --> 00:20:55.039
Get the C Corp, get the more complicated 401k, the more complicated reporting, the more complicated tax outcome.
00:20:55.200 --> 00:20:58.799
And so, but I just don't think people most people need to go there.
00:20:59.200 --> 00:21:13.279
So I want to I want to just say this in summary, because as I I've felt this talking through all of these points today, is that there are so many options for you out there with a retirement account.
00:21:13.440 --> 00:21:18.799
You in fact, many times we don't even know what to ask, right, when we're in an area that we're not familiar with.
00:21:18.960 --> 00:21:23.839
And I really want to encourage you to meet with one of our lawyers, a KKOS Lawyers.
00:21:24.559 --> 00:21:35.279
This is our firm that Matt and I have had for over 20 years helping small business owners all over America start their own businesses or and or use their retirement accounts.
00:21:35.599 --> 00:21:39.920
And we can suggest ideas and options you may not even be thinking about.
00:21:40.079 --> 00:21:42.720
But take the notes from today and bring it.
00:21:43.279 --> 00:21:44.079
Well, what about this?
00:21:44.160 --> 00:21:44.880
Well, can I do that?
00:21:45.039 --> 00:21:45.839
Can I do this?
00:21:46.079 --> 00:21:50.960
Push, you know, ask those tough questions, and we would love to answer them.
00:21:51.200 --> 00:21:58.079
And so I think this is a great conversation starter on your dreams, a better using your retirement account.
00:21:58.160 --> 00:22:03.680
Because if you're listening to the show, you already know your retirement account can do a lot more than just a Wall Street product.
00:22:03.920 --> 00:22:05.920
So let's find the solution for you.
00:22:06.079 --> 00:22:12.480
So down below is a link to KKOS Lawyers, at least book a discovery call and see where we could be of service.
00:22:12.799 --> 00:22:17.599
Yeah, and if the self-directed IRA works for you, we can set those up, of course, at directed IRA.
00:22:17.839 --> 00:22:19.839
There are limited situations for Robs.
00:22:20.000 --> 00:22:21.920
We can refer you to people that do set those up.
00:22:22.000 --> 00:22:24.880
If that is, you're in that little sweet spot where it does make sense.
00:22:25.039 --> 00:22:26.000
So thanks everyone.
00:22:26.079 --> 00:22:31.440
Hopefully, this is helpful in illustrating the differences between ROBs and self-directed IRAs.
00:22:31.680 --> 00:22:33.279
Make sure you're subscribed.
00:22:33.440 --> 00:22:39.200
However, you're consuming this on the podcast, on YouTube, make sure you're subscribed so you get updates on future shows.
00:22:39.359 --> 00:22:40.160
Thanks for being here.
00:22:40.400 --> 00:22:41.200
Till then, stay calm.