3 Ways to Fund your Business with Retirement Savings

Entrepreneurs who are looking to start, acquire, or grow a business often consider using retirement funds.  For many people, their 401(k) or IRA may represent their largest amount of savings.

There are three ways you can access retirement funds to invest in yourself and your own business.

1 – Take a Distribution

It is possible to take a distribution from a 401(k) or IRA retirement plan.

This is not normally best way to fund your own business because it creates a taxable event.

If you have a tax-deferred plan, the amount withdrawn will be taxed as regular income at the federal level as well as in your state of residence if it has an income tax.  If you are under normal retirement age of 59 ½, there will also be a 10% penalty for early distribution.

You could be left with as little as 50% – 60% of the distributed amount after taxes.  Ouch!

In a Roth plan, the distribution may be tax-free, but you can still be subject to a 10% penalty for early distribution of investment earnings if you are under age 59 1/2.

About the only time it makes sense to take an early distribution from a retirement plan is if you only need a very small amount and do not have easy access to other forms of credit.

2 – Solo 401(k) Loan

As a 401(k)-style retirement plan, the Solo 401(k) offers a participant loan.

If your business operates in an owner-only fashion and does not have any non-owner employees, you are eligible to establish a Solo 401(k) and rollover an old IRA or 401(k) into that new plan.

For limited capital needs, this can be a great way to access some cash for your business.

Following are the details of how the Solo 401(k) loan works:

  • You may borrow the lesser of 50% of your participant account value or $50,000.
  • The loan is for a 5-year maximum term.
  • The interest rate is set at prime +1%
  • Payments must be made on an amortized basis, at least quarterly.
  • You may take up to 3 loans at any time, up to the borrowing limit.
  • There is no penalty for pre-payment of a loan.
  • Loans are participant specific. If both you and your spouse have savings within your Solo 401(k), each of you can borrow up to your respective limit.
  • If you fail to repay the loan, it is considered a distribution and taxed accordingly, including early distribution penalties if applicable based on your age.

Because the Solo 401(k) loan is limited to a maximum of $50,000 and a 5-year term, it may not be sufficient for larger ventures.

If you have a business with moderate capital needs and just want to have a bit of buffer to get it up and running or get through a growth phase, the Solo 401(k) loan may be just the tool for the job.

3 – Rollover as Business Startup

Your retirement savings can directly invest in your own business with a Business Funding IRA.  There is no limit on the amount and no taxes or penalties.

For larger ventures, this is the program of choice.

This program is often referred to as a Rollover as Business Startup or ROBS plan but is not just for startups.  The strategy can be applied to both new and existing business projects.

The ROBS structure works as follows:

  • The operating business must be a sub-chapter C corporation.
  • The business establishes a 401(k)-style retirement plan.
  • As an employee/owner of the business, you can rollover funds from a prior employer tax-deferred IRA, 401(k), or retirement similar plan.
  • The 401(k) plan then uses an employee stock option purchase (ESOP) to acquire shares of the parent corporation.
  • The plan is now a shareholder of the business, and the plan capital is available to the business for startup, expansion, or other legitimate business capital needs.  You can even pay yourself a salary.

There are no taxes associated with this strategy.

There is no limit on the amount of funds you can rollover.

Because of the administrative infrastructure required for this plan, we do not recommend this solution for rollover amounts of less than $100,000.

Invest in Yourself Wisely

Being able to use retirement savings as a means to provide startup or growth capital for your business can be a game changer.  Sometimes it can be the difference making capital that allow you to invest in yourself and your dreams.

You should always proceed with caution when thinking about tapping your retirement savings for any purpose, however.  Make sure your IRA or 401(k) is the best available source of funds.  Sometimes a SBA loan or taking on an investor or partner can be the better play.

And be sure you have a good vision and a good plan to protect and grow your savings.  Having a professional like a CPA review your business plan before moving ahead is wise.

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