4 Powerful Ways to Use Your Retirement Funds to Start a New Business

Entrepreneurship is a dream that many people nurture, but few can achieve. Starting a new business is risky, expensive, and complex. 

However, the most challenging part is not accepting the risk or coming up with an idea but finding the funds for the capital to start the venture. Many people have now begun using retirement funds to start a business. It is considered a potential source of capital to start their own business.

This article will discuss four ways to use your retirement funds to start a business. Please note that the details in this article are the different options available to you and are not meant to give personal advice.

4 Ways to Use Your Retirement Funds to Start a Business

1. 401(k) Plan Loan

If your 401(k) plan allows you to avail of a loan, you can borrow either $50,000 or 50% of your account value, whichever is less. Generally, you have five years to repay the loan, with quarterly payments. The interest rate of the least prime is around 4.75%. There are some significant advantages of taking a loan against your 401(k) plan –

1. You get tax-free and penalty-free use of your money
2. You can avoid paying higher interest rates with outside lenders and banks.

The disadvantages of taking out a loan against a 401(k) plan are – 

The amount of funds you can borrow is limited

The amount you borrow will not earn any money as it would when invested elsewhere.

2. Taxable Distribution

If you have an individual retirement account or IRA, you may take taxable distribution anytime. However, if you are younger than 59.5 years, you must pay an early withdrawal penalty, and taxes will apply. Conversely, you can withdraw from your retirement funds anytime with a Roth IRA. Here are some advantages of withdrawing from an IRA for starting a new business –

It is a simple option if you are more than 59.5 years of age

Money from an IRA is not a loan but funds that you needn’t repay

Some disadvantages of this option are – 

1. You should satisfy several triggers before you are allowed to withdraw the money. For example, you should be 59.5 years of age, or your Roth IRA account should be at least five years old, etc.
2. Your retirement savings grow in a tax-advantaged way; if you withdraw, you lose the growth and the protection your money has.

3. Self-Directed IRA

A Self-directed IRA is an individual retirement account wherein you can invest your retirement funds in unconventional avenues such as real estate and cryptocurrencies. If you wish to use your funds in a Self-Directed IRA to fund your business, you may only do so if the IRA will be a passive minority investor of less than 50%. Here is a look at an advantage of this option –

1. It is one of the most popular options among IRA savers to make alternative asset investments.

There are some significant disadvantages of using a Self-Directed IRA for setting up a new business – 

1. IRS-prohibited transaction rules under IRC 4975 will likely prohibit the investment.
2. If the IRA owner and/or a disqualified person wants to own more than 50% of the business, IRS-prohibited transaction rules will prohibit the investment.

4. ROBS

The Rollover Business Startup Solution or the ROBS 401(k) is the only legal way to fund a new business using your retirement savings. In this case, an entrepreneur with a ROBS 401(k) can roll over the funds in their retirement account to another qualified retirement plan into a newly adopted 401(k) that belongs to their company. Here are some advantages of using the ROBS option to fund your business –

1. This benefits those wishing to establish a franchise, as franchises have a significant startup cost.
2. There is no limit to the funds you can withdraw from your retirement account.
3. You can be personally involved in the business and take a salary.

Some disadvantages of this option are listed below – 

1. ROBS must involve a 401(k) plan and a C corporation
2. Due to the complexity of ROBS, when you borrow money, you probably need a tax consultant to walk you through the consequences
3. There is double taxation; the business gets taxed, and the shareholders also get taxed

Which Option Is Right for You?

Investing your retirement funds in your new business can raise the stakes in your startup manifold. The best option among the four options described above, the best choice for you depends on your need for capital, your age, and where your money lies. Each of the above options has positive and negative consequences associated with them.

Consider all the advantages and disadvantages carefully before choosing the right option. When using your retirement funds, the amount you get may be limited; remember to plan the best way to repay the amount you borrow or withdraw. 

Finding sufficient capital for your business can be challenging. If you don’t have strong investors or a small need that no other source can fulfill, dipping into your retirement funds can give you the much-needed boost to kickstart your business.