Should You Use Retirement Funds to Start a Business?

You have a great idea that you want to turn into a new business, but you don't have enough cash, capital, or funding to bring it to life. There is a way to work around this problem. If you own a 401(k), IRA, or any other qualified retirement account, you can use this money to fund your new venture.

Don't take the risk of using retirement funds lightly

Many financial advisors will advise you to not tap into your retirement savings because startup businesses are inherently risky. Retirement funds should be parked only in those assets that do not compromise the safety of your money. Besides, the funds need to be diversified across asset classes so that any one wrong investment decision does not hurt the portfolio returns.

However, despite all the risk that financial advisors will warn you about, there are bold entrepreneurs who are passionate about their ideas, and these entrepreneurs are generally unstoppable. They are convinced about the potential success of their business ideas, and they're not worried about failing and losing their retirement nest egg. In fact, they frequently believe that the risk they are taking today will only make their retired life more fun and better funded.

The legalities of pulling money from retirement savings

The process of using retirement savings to fund a business is fairly simple, but there are details to be aware of:

• You will need to issue stock from your new business to your retirement fund.
• Your new business will be incorporated as a C-corporation and with it you will set up a qualified retirement plan. The retirement plan is usually a profit-sharing plan that is permitted to invest in employer stock.
• Once the plan is set up, you will join your business as an employee and enroll in the plan. Funds from your retirement account will be rolled over to the new retirement plan. The rollover is tax free.
• Your new venture is owned by your retirement fund.

It is usually best to hire a firm that has experience in such dealings. You might have to shell out a hefty fee for this, but it is generally worth the money.

The advantages of using retirement savings

There are, of course, good reasons that many entrepreneurs have gone this route in order to get access to the funds they need to start a business. The biggest are:

• You will be using tax-deferred savings to fund your business.
• You can avoid the hassles of loan and debt.
• Your credit score does not matter.
• The process is quick and in a matter of few weeks you get access to the funds.

The disadvantages of using retirement money

Besides the huge risk of losing your nest egg that is meant to get you through your later years, a flip side of using retirement funds is that you are exposed to increased scrutiny by the IRS. The IRS is generally suspicious of such transactions, and therefore they are likely to probe your financial details.

They want to ensure that the correct procedures are being followed and there are no wrongful intentions. However, if the IRS smells something foul, they might treat the distribution as taxable.