BOSTON (TheStreet) -- Retirees, especially Baby Boomers used to the fast-paced life of their professions, are turning entrepreneurial and tapping into their 401(k)s and IRAs to start new businesses, often doing so without penalties and taxes.
In the past, antsy retirees unaccustomed to endless daytime TV, golf and buffet lunches eventually rejoined the workforce. Today, a lurching economy has meant fewer jobs to choose from as well as increased competition that favors youth over experience.
Newly retired Americans are seeing their second act in the workforce as a necessity, as retirement plans were hacked in half by the stock-market crash while fixed-income investments hardly pay any interest. For retirees with nowhere else to turn for financing, some are using a tax-code loophole to cash out their 401(k) or IRA funds for seed money without incurring the 10% early-withdrawal penalty or a tax hit.
The process is known as Rollovers as Business Startups, a name the IRS, perhaps tellingly, refers to by the acronym ROBS. Len Fischer, founder and chief executive officer of retirement-plan designer BeneTrends, says his ROBS-related business has grown 40% a year during the past three years.
Retirees "sit there and stare at the money and say, 'I'm not making anything off it anyway, why not take a chance and try to do something special with it,' " says Ed Deicke, managing partner at Plainview, N.Y.-based North Shore Wealth Management, a JHS Capital Advisors Company.
Traditional sources of financing a new business are bank loans and tapping into home equity. Banks, however, have tightened credit lines since the recession that began in late 2007 and the TARP bailouts that followed. Small-business lending has dropped by $40 billion to $670 billion in the past two years. Meanwhile, plummeting real-estate values, both commercial and residential, have devalued the collateral used to secure equity-based loans.
ROBS begin with a potential business owner creating a C-corporation and establishing a retirement plan for its employees. The owner's previous 401(k) or IRA funds are then rolled over into the new plan, which has been constructed as a qualified profit-sharing plan. The plan document provides that all participants can invest the entirety of their account balances in "employer stock."
Next, the owner "directs" the new corporation to exchange its capital stock into the plan for the funds it holds. The stock is valued to reflect the amount of plan assets he or she want to access and the proceeds are, effectively, withdrawn penalty-free.
Once the cashing out is complete, the plan is often amended so the ability to invest in employer stock is removed. By law, the plan must then be made available to any new employees and is subject to all federal regulations regarding fiduciary responsibility.
Since it was founded 15 years ago, Fischer's BeneTrends has worked with about 6,000 clients to fund new businesses via retirement plans. On average, they leveraged nearly $175,000, and 70% of the deals have involved franchise offerings. More entrepreneurial customers have started businesses that range from an ecological research company to a tugboat operator based in Baltimore's inner harbor.
To that point, he recommends that clients spend two to three months on a full analysis and review of their business plan. It is also suggested that retirement funds only be tapped when other sources of funding, such as an SBA small-business loan, run dry or are unobtainable.
Industry-wide, in 2009, ROBS were used for 4,050 business start-ups. The study makes the claim that, for every 500 ROBS transactions, $1 billion in total economic output is created and 7,648 jobs are added.
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