Considering using your 401(k) to start a business? According to Fidelity Investments, the average retirement account balance is at an all-time high, and the number of 401(k) millionaires continues to grow. That's a lot of cash invested in the markets. For some entrepreneurs, financing a business launch is an equally savvy way to grow those retirement dollars.
Depending on the amount of money you've put aside and the amount you need, there are two ways to leverage your retirement savings and bootstrap your business.
Borrowing from your 401(k) may be the answer if:
- Your credit score or a time crunch makes securing funds through traditional lending impractical.
- Your plan allows loans. Consult your plan documents -- they don't all allow borrowing, and those that do have varying rules on repayment.
- You need less than $50,000. IRS regulations set the maximum loan amount at $10,000 or 50 percent of your vested balance (whichever is greater) with a cap at $50,000.
- You intend to stay at your job while starting your business. If you leave your job or your employment is terminated, you will have to repay the loan or pay the tax consequences of early withdrawal.
- You have a solid plan for repayment. If your need for funds is short term--to purchase a franchise, for example, or invest in equipment--and you anticipate a quick return on that investment, borrowing from your savings may be a responsible choice.
What steps are involved in borrowing from my 401(k)?
- Make sure you have no other option. In general, tapping into your retirement savings is a big deal. You will not be able to make contributions or take advantage of company matching while you have an outstanding loan.
- Contact your HR department to learn about the details of your plan.
- Pay yourself back as soon as possible. When your loan is repaid, you can once again contribute and take advantage of employer matching.
A rollover for business startups (ROBS) may be the solution if:
- You cannot qualify for a business loan, due to credit issues or time constraints.
- Your retirement plan qualifies. It cannot be a Roth 401(k), for example.
- The administrator of the plan allows it. Many employers do not allow the rollover of funds from your 401(k) while you are still employed. Funds from previous employer plans will qualify.
- You need $50,000 or more to launch your business. ROBS is a complex process. Whether you put the entire rollover into the hands of a financial services provider or do it yourself, you will incur legal, accounting and administrative fees. Providers consider this the amount at which the accompanying fees make sense.
- You will be an employee of the business.
What are the steps to complete a ROBS?
- Form a C Corporation. If your business is already formed as an LLC or other entity, you will need to reformat. A C corp is the only business entity that can sell shares to a retirement account, which is the key to releasing the funds you need to start your business.
- Open a 401(k) plan for your new business. Depending on the number of employees, how highly some will be compensated and other factors, you will want to choose the right plan. You will most likely need a custodian to manage the plan. Take advantage of their expertise when deciding what type it will be.
- Roll over funds from your old retirement plan to the new one. The plan administrator will assist with this process.
- Issue stock (ownership shares) in the new C-corp, which the retirement plan purchases. This is the key step--the mechanism that actually puts the funds at the disposal of the business.
- Follow the rules. There are a lot of them. If you have employees, for example, those who are eligible must be allowed to invest at the same level as the business owner. There are restrictions on owner compensation and on the personal use of business property. The financial services companies that administer ROBS can help you stay on the correct side of regulations.
Removing money from a retirement account requires careful consideration of the costs and a frank assessment of the risks--beyond those inherent in any new business venture. The bottom line is that startups need cash. Tapping your retirement savings is one way to get it.