Using a 401k For Business Financing

By: First Union | Date:

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Using a 401k For Business Financing

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In order to get funds for your business, there are of course a variety of loan options you can explore. Also, one thing that a number of entrepreneurs do to help seed their business is to use retirement funds. The question is: does it really make sense to tap into your 401k to help get your company going or even to infuse your business with more capital when it needs it?

Things to Consider As Far As Using a 401k to Start a Business

Keep in mind, if you are going to make use of that 401k for the purposes of your business endeavor, there are three possibilities:

  • ROBS 401(k/)
  • Traditional 401(k/)
  • Retirement Account Distribution

With the ROBS 401(k/), (Rollovers as Business Startups/) you actually do not encounter any penalties or fees, not to mention, you avoid taxes. For that reason, ROBS 401k is a very popular option. You can thus use it to start a business without the tax burden associated.

Not every retirement plan allows you to borrow against it when it comes to funds for business use. With the 401(k/), 403(b/) and 457(b/) plans, this is a possibility, however. On the other hand, an IRA prohibits such use unless you can repay it within 60 days.

Understanding the ROBS 401(k/)

If you are going to use a ROBS 401(k/), then what this means is that the assets from relevant retirement accounts are rolled over into your new business venture, or also an existing business. The best way to manage this is to utilize the services of a financial expert or an attorney. In rolling over these funds, you still maintain the tax-deferred status and are therefore not susceptible to penalties.

The money going into your business is considered an investment—this is why you are not charged the 10% early withdrawal penalty.

The procedure for a ROBS 401(k/) goes as follows:

  • You generally form a C Corp. This then lets shareholders invest in the new company. A 401k is then set up.

  • As the owner, you can roll your existing retirement accounts into this 401k plan.

  • These funds can then be utilized to purchase stock, which allows you to invest in the company.

For those with over 50k in retirement funds, a ROBS is a great way to go. Also, keep in mind the following if establishing this type of 401k plan: you have to be active in the company itself. This is not the solution for someone who intends to be a silent partner or who is simply looking for a side investment.

It's always a good idea to ensure that you have additional monies in retirement accounts so that you are not exhausting all of your resources to this end. Meaning, if you pull from your retirement to invest in your business, are you going to have funds left over for retirement itself?

Understanding a Traditional 401(k/)

Again, if there is a significant amount of funds involved, then the ROBS is probably the best way to go. However, if you do not plan to quit your day job, and don't need as much capital to start a business, you might consider a traditional 401k.

You cannot withdraw more than $50,000 or half of your balance. And you are then tasked with repaying the loan, similar to how you would a business loan with the payback term generally not exceeding five years. The interest rate would be set by the fund administrator.

If you're not going with a ROBS 401K, you can borrow against your 401k or IRA under the following conditions:

  • You're remaining at your current job
  • You don't need more than 50k
  • The income from your business will be passive income
  • You are able to repay it within a 60 day period

By repaying the loan within 60 days, you may be able to avoid fees and penalties. While this is not guaranteed, if you do go over sixty days you almost always face penalties.

With both traditional or Roth IRA's though you cannot withdraw funds as permitted by something like a 401k; you can take out money penalty-free under certain circumstances, to include: educational fees, medical costs not covered by insurance (that which exceeds a certain percentage of your income/) and well as healthcare premiums should you find yourself unemployed.

Do keep in mind though that there is no provision for taking money out penalty-free in the event that you're trying to start or fund a business.

Understanding a Retirement Account Distribution

Taking a distribution from a retirement account in order to fund a business is also known as cash out. With this, there is a penalty if you're under 59, and the money once withdrawn, is also considered taxable income. While there are some qualifying distributions, starting a business is not one of them.

You first need to ask for the requisite paperwork from the retirement account company. It's important to remember that as you're withdrawing funds prior to retirement age, this can be a lengthy process, with many moving parts. Certain plans may not allow you to take disbursements at certain times of the year—or even only restrict it to once a year.

Again, once you do receive the disbursement, this will have to be declared as income. Usually going this particular route represents a last resort once all other options have been explored. If you are 59 or older, this process may be more viable. Or, if you've had the IRA for more than 5 years while making substantial contributions, this could also be a more relevant solution for you.

So Should You Consider Using a 401(k/) for Your Business?

While this is certainly an option for you—it is not the ideal choice. If you are 59+ then it makes more sense; however, if you are younger than that and currently do not have a significant amount in your 401k (meaning enough to fund a business and your retirement/) then it may not be the smartest move.

Prior to liquidating your retirement accounts, you most definitely should look into all of the business financing solutions available. Even check into the possibility of a business credit card. The point is, do your research, explore all relevant avenues and then if you're still short the money required, only then consider taking some of the money out of your 401k. At First Union, we offer multiple loan options if your business is in need of funding from lines of credit to short term loans. Call today to find out how we can help you!

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