A rollover as business start-up defers the income tax rather than avoiding it, so the true saving is the penalty less the fees.
To put $150,000 of equity into a business purchase, cashing out a 401(k) at an illustrative 29 per cent income tax plus the 10 per cent additional tax drains $245,902 from the account; a rollover as business start-up (ROBS) moves exactly $150,000. But ROBS defers the income tax rather than avoiding it, so measured in after-tax wealth its real advantage is the $24,590 penalty less about $14,000 of five-year fees: $10,590.
Worked in full in Buying a Small Business by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Buyers who look at ROBS usually see the first number, $95,902 of tax not paid, and stop. The second number is the one that decides whether ROBS is worth its fees, its paperwork and its constraints, and for a small equity cheque it can be negative.
The buyer forms a C corporation, which sponsors a new 401(k) plan. The buyer rolls existing retirement savings into that plan, tax-free as a rollover, and the plan uses the money to buy shares in the C corporation. The corporation now has cash for the down payment, and the buyer's retirement plan owns the company. Many SBA lenders accept these funds as the buyer's equity injection, and the details of the injection are in how much cash you need to buy a business with an SBA loan.
| Input | Value |
|---|---|
| Purchase price | $1,500,000 |
| Equity injection, 10% of price | $150,000 |
| Existing 401(k) balance | $300,000 |
| Marginal income tax: federal 24% + state 5% | 29% |
| Additional tax on early distributions | 10% |
| ROBS set-up fee | $5,000 |
| ROBS plan administration, per year for 5 years | $1,800 |
A flat 29 per cent understates the tax on a large withdrawal, which can push the buyer into a higher bracket. That would favour ROBS further. Some states add their own early-withdrawal tax, and some exceptions remove the federal 10 per cent, for example leaving the employer in or after the year you turn 55 for money still in that employer's plan. Check which apply before running the numbers.
Gross = net ÷ (1 − income tax − penalty) = 150,000 ÷ (1 − 29% − 10%) = $245,902
Income tax = $71,311; penalty = $24,590; total $95,902
Left in the 401(k): $54,098
Excel: =150000/(1-0.29-0.1)
Rolled into the new plan and invested in the company: $150,000
Left in the old 401(k): $150,000
Fees over 5 years: 5,000 + 5 × 1,800 = $14,000
Everything inside a retirement plan will be taxed at 29 per cent when withdrawn, including the company shares ROBS puts there. Value each route in today's after-tax dollars, before any growth:
| Item | Cash out | ROBS |
|---|---|---|
| Business equity: owned directly vs inside the plan (× 0.71) | 150,000 | 106,500 |
| Remaining 401(k) after tax (× 0.71) | 38,410 | 106,500 |
| ROBS fees over 5 years | 0 | −14,000 |
| After-tax wealth | 188,410 | 199,000 |
The difference is $10,590: the $24,590 penalty ROBS avoids, less the $14,000 of fees. The $71,311 of income tax is not saved. In the cash-out route it is paid now; in the ROBS route the equivalent tax waits inside the plan, on the shares and on the money left behind, and is paid on withdrawal in retirement.
The fees are largely fixed and the penalty is proportional, so ROBS has a break-even. Penalty = 10% × E ÷ (1 − 39%) equals $14,000 when E = $85,400.
| Equity needed | Gross withdrawal | Income tax (deferred by ROBS) | Penalty (avoided by ROBS) | ROBS fees | Net advantage of ROBS |
|---|---|---|---|---|---|
| 50,000 | 81,967 | 23,770 | 8,197 | 14,000 | −5,803 |
| 100,000 | 163,934 | 47,541 | 16,393 | 14,000 | 2,393 |
| 150,000 | 245,902 | 71,311 | 24,590 | 14,000 | 10,590 |
| 250,000 | 409,836 | 118,852 | 40,984 | 14,000 | 26,984 |
A buyer over 59½ pays no additional tax, so cashing out $211,268 nets the same $150,000 and ROBS saves nothing permanent: it costs the $14,000 of fees and buys only the liquidity and deferral.
ROBS is a liquidity tool with a modest tax saving: the 10 per cent penalty less its fees, here $10,590 on a $150,000 injection and negative below about $85,400. Decide on the cash constraint and the C corporation consequences, not on the headline tax. This is an illustration, not tax advice: have a tax adviser and an ERISA specialist review the structure. The book's two acquisition models, with sources and uses for an SBA deal, are on the Buying a Small Business companion page.
It avoids tax now, not tax ever. The rolled funds buy company shares inside the new 401(k), and plan withdrawals in retirement are taxed as ordinary income. In the illustrative case ROBS avoids $95,902 of upfront tax, but only the $24,590 penalty is a permanent saving; after $14,000 of fees the after-tax advantage is $10,590.
Providers typically charge a set-up fee and an ongoing plan administration fee; this example assumes $5,000 and $1,800 a year, $14,000 over five years. Against the 10 per cent additional tax on an early withdrawal, that only pays for itself on an equity injection above about $85,400 for a buyer under 59½.
Rarely on tax grounds alone, because there is no additional tax to avoid: cashing out $211,268 nets $150,000 at an illustrative 29 per cent rate, and ROBS just defers that tax while costing $14,000 in fees. It can still make sense when the cash at closing is the constraint, since all of the balance reaches the deal.
This article is one calculation from Buying a Small Business. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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