How to Use a 401(K) to Start a Small Business
Create a business plan, before looking for funding or quitting a job to start a small business., Attempt to find investors and bank funding outside of your 401(K)., Understand the rules of 401(K) loans., Decide if you would like to stay employed at...
Step-by-Step Guide
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Step 1: Create a business plan
Proof it well and ask successful business owners, partners and friends to look over it for you.
Adjust the business model, marketing strategy, financial strategy and time line, if needed. -
Step 2: before looking for funding or quitting a job to start a small business.
While a 401(K) is a way to remain independent from outside investors, it increases the financial burden and risks that rest on your shoulders.
If you take 401(K) loans out, your retirement account will not grow as substantially as it would if the money stayed in the account.
Investing with your 401(K) carries 2 major risks.
The first risk is that you will lose the money if your business fails, and the Small Business Administration reports that over 50 percent of small businesses fail within 5 years.
If you do not pay back the 401(K) loan within 5 years, you are penalized, and you will still have to pay the penalties and taxes that go along with early fund withdrawal from a retirement account. , Most 401(K) plans allow you to draw a loan of less than 50 percent or up to $50,000 without early withdrawal penalties or tax payments.
You must repay this loan within 5 years, or you will have to pay those penalties.
Ask your company's 401(K) investor contact what the specific rules are for taking out a loan from your 401(K).
They can differ slightly from company to company.
You may be subject to repaying 1 to 2 percent interest on the money you borrow. , Based on your decision there are 3 options for you to arrange your 401(K) loan.
If you plan to stay employed at your current job, then you can simply call the investment firm to arrange the loan.
You will need to complete and sign loan paperwork when you withdraw the money, and set a date when it has to be repaid in full.
If you plan to quit your job, set up a 401(K) immediately at your new company.
Decide on a good investment firm or bank to handle your 401(K), and then transfer your retirement savings from your old job to your new company.
Once that is set up, take a loan out from your 401(K) at your small business.
The third option is more complex, and is called a Rollovers as Business Start-ups (ROBS) loan.
Meet with a lawyer, a certified public accountant and an investment firm that specializes in ROBS loans, to discuss if you can legally set up stock options for your business.
Then, when you transfer your 401(K) to your new company's investment firm, you can use retirement money to invest in stocks from your own company.
This is most often used for franchising an already-existing business.
It is a complicated process and requires adherence to strict rules to ensure you are following the law. , If your investor or bank loan funding is falling short, then ask all of your partners to look into getting loans from their 401(K) plans.
If you are risking losing retirement money, then perhaps your business partners are willing to take the risk. , Use it immediately to start your business.
You will need to begin your plan to turn a profit as soon as possible, because your loan will be due within 5 years. , In most cases, you can create a plan to repay the loan through payroll deductions to your own, or your employer's, 401(K).
You will need to add these distributions to your annual income when you file your taxes.
If you started your small business, but you are borrowing from another employer's 401(K) plan, you must pay the loan back immediately if you quit your job. -
Step 3: Attempt to find investors and bank funding outside of your 401(K).
-
Step 4: Understand the rules of 401(K) loans.
-
Step 5: Decide if you would like to stay employed at your current job while you start your small business
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Step 6: or if you plan to quit and run the business exclusively.
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Step 7: Decide if you want to pool 401(K) loans from partners to start a business.
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Step 8: Cash the loan check in your new business account.
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Step 9: Create a plan to repay the money.
Detailed Guide
Proof it well and ask successful business owners, partners and friends to look over it for you.
Adjust the business model, marketing strategy, financial strategy and time line, if needed.
While a 401(K) is a way to remain independent from outside investors, it increases the financial burden and risks that rest on your shoulders.
If you take 401(K) loans out, your retirement account will not grow as substantially as it would if the money stayed in the account.
Investing with your 401(K) carries 2 major risks.
The first risk is that you will lose the money if your business fails, and the Small Business Administration reports that over 50 percent of small businesses fail within 5 years.
If you do not pay back the 401(K) loan within 5 years, you are penalized, and you will still have to pay the penalties and taxes that go along with early fund withdrawal from a retirement account. , Most 401(K) plans allow you to draw a loan of less than 50 percent or up to $50,000 without early withdrawal penalties or tax payments.
You must repay this loan within 5 years, or you will have to pay those penalties.
Ask your company's 401(K) investor contact what the specific rules are for taking out a loan from your 401(K).
They can differ slightly from company to company.
You may be subject to repaying 1 to 2 percent interest on the money you borrow. , Based on your decision there are 3 options for you to arrange your 401(K) loan.
If you plan to stay employed at your current job, then you can simply call the investment firm to arrange the loan.
You will need to complete and sign loan paperwork when you withdraw the money, and set a date when it has to be repaid in full.
If you plan to quit your job, set up a 401(K) immediately at your new company.
Decide on a good investment firm or bank to handle your 401(K), and then transfer your retirement savings from your old job to your new company.
Once that is set up, take a loan out from your 401(K) at your small business.
The third option is more complex, and is called a Rollovers as Business Start-ups (ROBS) loan.
Meet with a lawyer, a certified public accountant and an investment firm that specializes in ROBS loans, to discuss if you can legally set up stock options for your business.
Then, when you transfer your 401(K) to your new company's investment firm, you can use retirement money to invest in stocks from your own company.
This is most often used for franchising an already-existing business.
It is a complicated process and requires adherence to strict rules to ensure you are following the law. , If your investor or bank loan funding is falling short, then ask all of your partners to look into getting loans from their 401(K) plans.
If you are risking losing retirement money, then perhaps your business partners are willing to take the risk. , Use it immediately to start your business.
You will need to begin your plan to turn a profit as soon as possible, because your loan will be due within 5 years. , In most cases, you can create a plan to repay the loan through payroll deductions to your own, or your employer's, 401(K).
You will need to add these distributions to your annual income when you file your taxes.
If you started your small business, but you are borrowing from another employer's 401(K) plan, you must pay the loan back immediately if you quit your job.
About the Author
John Powell
Brings years of experience writing about cooking and related subjects.
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