Getting funding for a startup, whether through state and federal grants or a small business loan, can be a challenge.

One possibility is to use tax-free money from your 401(k), but that has some potential drawbacks. Creating a C-corp to hold a new 401(k) and then rolling the money from the old one into it is complicated and, if you are still holding a job, might raise questions about your future plans.

But there's another way of using a 401(k) that can be good if you're starting out small, don't want to telegraph the possibility that you might leave a position, and want to protect your retirement. Instead of cashing out the 401(k) and paying a big tax penalty or creating a new corporation, take a loan from the savings. It's much lower key, less involved, and you can borrow up to $50,000 or half your balance, whichever is lower. There has been one big problem, but the tax cut bill passed last month lessens the problem.

Borrowing money from your retirement fund can be risky. If things don't work out well, you could leave yourself further behind in the future. So, this route shouldn't necessarily be your first choice in any case. In addition, because you pay interest on the loan, even at a low rate, you do so with after-tax money. Then, because disbursements are taxable, you could pay tax twice (although likely at a lower rate when you retirement as your income will probably be lower).

The big additional issue came about because of the laws governing 401(k) plans. If you left your job, you would have only 60 days to repay the loan or it would count as an early distribution, which means taxes at your current income (including the amount you withdrew, which could increase the marginal tax rate) and a 10 percent penalty.

However, part of the tax cut bill said that if you leave your job, you get up to October of the following year to repay the loan or add the money to a 401(k) at your new employer or to an IRA. That helps take the pressure off.

You still should think over carefully whether to pull money out of retirement, where it can grow in value and also remain protected from bankruptcy proceedings, should the new venture go south. But if you're bound and determined, this may be welcome news.

Published on: Jan 17, 2018