At 62, He Has $750,000 in a 401(k). A Rollover Could Put $250,000 Into a New Franchise Without Immediate Federal Tax

A 62-year-old can shift $250,000 from a 401(k) into a franchise without triggering an immediate federal tax bill. The tradeoff is that the retirement plan becomes the investor, and the IRS remains involved long after the funds are moved.

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He is 62, has $750,000 in a traditional 401(k), and wants to direct $250,000 of it into a franchise. If he simply withdrew that money, the full amount would normally be treated as ordinary income in one tax year. A Rollover as Business Start-Up, or ROBS, allows the same money to be used for the business with $0 federal income tax upfront.

That said, this is not just a financing trick for a franchise. His new retirement plan would own an investment in the company, putting one-third of his 401(k) savings into a single business. The tax benefit at the start is real, but so are the concentration risk and the ongoing compliance duties that come with ownership.

How Retirement Savings Are Converted Into Business Funding

A ROBS works through several steps. He would set up a new C corporation to own the franchise, establish a qualified retirement plan for that corporation, and enroll as an employee. He would then roll $250,000 from his old 401(k) into the new plan. After that, the plan purchases stock in the C corporation, and the corporation uses the money to pay for the franchise fee, build-out costs and opening inventory.

In effect, he owns the franchise indirectly through his retirement plan, and the business must be a C corporation because the plan is buying employer stock.

Why the $250,000 Can Move Without Immediate Federal Income Tax

Withdrawals from a traditional 401(k) are usually taxable, but a direct rollover to another qualified retirement plan generally is not. Sending the $250,000 straight to the new plan also avoids the 60-day deadline that applies when the money is paid to him first. IRS guidance on rollovers says direct transfers may be made by wire or by a check payable to the receiving plan.

Once the rollover is complete, the plan uses the $250,000 to buy stock, which counts as a plan investment. The rollover is still reported on his tax return, but when the transaction qualifies, the taxable amount is generally $0. He is also beyond the age at which the early-withdrawal penalty applies. The main advantage of a ROBS is avoiding immediate ordinary income tax on a quarter-million-dollar distribution.

One-Third of His Retirement Money Is Now Tied to the Franchise

The franchise investment represents 33% of his 401(k). That leaves $500,000 in the more diversified portion of his retirement savings. If the business fails, the plan’s shares could become worthless, erasing that slice of his nest egg. IRS compliance checks have repeatedly identified failed businesses as a common ROBS problem.

Social Security is another factor. He must be a legitimate employee of the company, although he does not necessarily need to draw a salary right away. If he begins benefits at 62, the earnings limit is $24,480. With a $60,000 annual salary, Social Security could withhold up to $17,760 in benefits, depending on his entitlement. He would also owe $4,590 in employee payroll taxes. For someone operating a franchise, delaying benefits may make sense.

IRS Rules That Stay With Him After the Business Launches

1. Plan administration: The C corporation sponsors the plan, and he serves as both owner and fiduciary. Help from a ROBS provider does not remove sponsor and fiduciary responsibility, so he needs a third-party administrator he actively oversees.
2. Employee eligibility: Franchises employ workers. Employees who meet the plan’s eligibility standards must be allowed to join, and the plan must comply with federal coverage rules.
3. Nondiscrimination: If only the owner could purchase company stock, the plan would favor him over other employees. IRS reviews often cite discrimination as a frequent failure.
4. Valuations: The stock must be valued at fair market value when the plan buys it and then at least once a year after that. An overstated valuation could create a prohibited transaction and possibly trigger an initial 15% excise tax.
5. Annual filings: The plan generally must file Form 5500, and the corporation must file Form 1120. Missing those filings can lead to penalties and IRS scrutiny, while serious violations can threaten the plan’s tax-qualified status.

What to Check Before Transferring the $250,000

A ROBS keeps the retirement money tax-deferred. If the retirement plan later sells its company stock, the proceeds stay inside the plan. If the corporation sells the franchise assets instead, the money remains with the corporation. Later withdrawals from his traditional retirement plan are generally taxed as ordinary income and could also raise Medicare costs through an income-related monthly adjustment amount, or IRMAA.

1. Stress-test the $500,000 assuming the franchise fails. Plan retirement withdrawals as if the business becomes worthless, and if the strategy only works when the franchise succeeds, $250,000 may be too much to commit.
2. Set pay with the earnings test in mind. Waiting on Social Security avoids reductions under the $24,480 limit and allows the benefit to continue growing.
3. Think through the exit with Medicare in mind. After enrollment, income from two years earlier generally helps determine whether higher premiums apply. When possible, spread post-sale withdrawals over several years using the thresholds that apply at that time.