Using Your 401k to Start a Business

If you’re thinking of buying or starting your own business but don’t have a lot of cash on hand, you’re probably wondering what your financing options are.  You might even be wondering whether or not you can use your 401k, IRA or other retirement account.  Believe it or not, there is a legal way to use your 401K or IRA to buy a business but it’s important you know the pros and cons of this risky provision in the IRS tax code.

Rollovers for Business Start-ups (ROBS)

The IRS does allow people to use their pre-tax 401K and IRA retirement funds to start or buy a business through a Rollover for Business Start-Ups (ROBS).  While “ROBS” is an ominous sounding acronym, Rollover for Business Start-Ups have led to the creation of many small business success stories.

401k Rollover for Business Start-up infographic

Step 1, You form a new C Corporation (C-Corp):  This sounds like a huge undertaking but starting your own C corporation an incredibly easy when you use a lawyer who is familiar with the process.

Step 2, Create a New 401k Plan: You start a new 401K plan for your new C-Corp corporation and roll your old 401K or IRA into the new C-Corp plan.

Step 3, Invest in Your New Business: Use your newly funded C-corp 401k to buy shares in your new business venture.

Step 4, Run Your New Business:  The money raised by your business by selling shares to your C-corp can then be used by your business for any expenses deemed ordinary or necessary under IRS tax law.  Whether buying equipment, office supplies or real estate used by the property.

Step 5, Your Investment: Your C-corp become a “shareholder” of your new business.

Benefits of using 401K or IRA Accounts to Start a Business

No loan payments:  One advantage to using 401k or IRA ROBS to start your business is the fact that funds used are not a loan.  You do not have to make monthly loan payments as you would by using a small business loan, home equity or other type of loan.  This significantly frees up cash-flow which is a major reason many business fail within the first few years.

Alternative Investment Option:  Many people are not comfortable investing in the stock market and put their family’s future in the hands of corporate CEOs and bankers.  401K ROBS allow people to invest in themselves and their ideas.

Risk of using 401k and IRA Accounts to Start a Business

Your Nest Egg:  Investing in your (yet unproven) business idea is an incredibly risky gamble especially if you don’t have a proven track record in the particular business you are thinking of buying or starting.  Nearly half of all new businesses fail within the first 5 years, is this a risk you’re truly willing to take with your retirement?

Ideal Candidate for 401k and IRA ROBS

There are many things you can do to improve your chances of success when using your 401K to fund the start-up or purchase of a small business.

Business Plan:  One of the most important things you can do is have a realistic business plan in place with realistic projects of cashflow whether you’re starting a new business or buying an existing one.  How will you reach new customers, what will you charge, and what will your monthly expenses be?

Assets:  If you’re buying an existing business, make sure you have an independent expert value the business and any assets it has.  How much physical property is included in the purchase?  If the business model were to fail, how much could the company be liquidated for down the road?  Paying $500,000 for a company with virtually no real estate or other assets, is a lot riskier than paying $500,000 for a business that included $400,000 is physical real estate that you could sell down the road.

How to get Started with a 401K or IRA Rollover for Business Start-Up Plan

While the concept behind 401k ROBS is straightforward, the paperwork and record keeping for IRS compliance can be incredibly burdensome.  Fortunately, there are a variety of companies that have filled in this niche quite with highly specialized products geared specifically for people considering using their 401k or IRA to start a business.

Cost to Start a Rollover for Business Start-Up Plan

Initial costs to establish a ROBS plan averages between $4,000 and $7,000 (depending on complexity) and another $1,000 to $2,000 per year to handle the necessary filing requirements for the IRS.

Are 401k and IRA ROBS Right for You?

Rollover for Small Business Start-Up plans are a viable way to fund the purchase or start-up of a new business and start you on the road to success; however, they’re not without their risk.  Be sure to consider your unique situation before utilizing this unique way of funding your business.  Make sure you’re not putting all of your eggs in one basket and have a reasonable “exit strategy” if things don’t go the way you planned.

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