Financing Your Business: A Case for Using Some of Your IRA, SEP, or 401(k)
Remember what your Mom used to say when you and she were shopping in an expensive store? "Look, but don't touch." These days, such a warning could apply to using tax-deferred retirement funds to fund start-up businesses. The prevailing wisdom holds that you should sock away money in these accounts, never, ever touching it -- unless you're ready for year-round golfing.
When looking for cash to start or expand their businesses, however, corporate refugees or diehard entrepreneurs (those on second, third, or subsequent ventures) may be well advised to consider using their IRA, SEP, or 401(k). One reason is that unless they're launching anybusiness-dot-com, venture capitalists won't be knocking down their doors. If your company is a typical one- or two-person start-up, you may find it difficult to get loans from family, friends, or special government programs.
Another reason for considering those funds is that you'll be making tax-wise use of your resources. Because you've enjoyed tax-deferred growth in these accounts, you have more money available than would otherwise be the case. When you use it to create wealth, you're allowing yourself access to your own venture capital fund.
Timing Is Everything
Before you jump up and say, "Eureka," remember that timing is everything. You must be careful about when you dip into your retirement kitty. At the start of your venture, it is probably smart to consider personal savings first, leaving an emergency fund equal to three months' living expenses to assuage the no-salary jitters. Into the savings category, add employee stock options you have exercised.
Next, turn to more easily accessible capital sources: the equity in your home, making sure to access only a portion -- perhaps a fourth to a third -- of what's available to you; loans from family or friends with fixed interest and payback stipulations; and credit from government and other specialty programs.
At this point, if you need additional cash, using retirement funds begins to make sense. You must still tread carefully. You don't want to risk your largest source of retirement income. Be sure your business plan has been shot full of holes by mentors and put back together again. Be confident about your ability to walk away and find employment if the venture doesn't succeed.
And be careful. Leave a minimum of $50,000 -- ideally $100,000 -- in your plan. If you are 55 or older, leave even more. But then be willing to take the plunge. What follows is how you do it.