As a small business owner, you have many options available to help fund your business. However, with traditional business loans you are risking taking on a lot of debt so if you do not feel like taking that risk, you can use your personal savings or retirement accounts like your 401(k) and individual retirement accounts (IRAs). In this article, we will discuss what you need to know about financing your business with a 401(k) and the pros and cons of using them.
When you want to use a 401(k) to start your business, you take on a different kind of risk. By withdrawing money out of your 401(k) or IRA before you are 59 ½, you need to pay income taxes on the money plus an early withdrawal penalty of 10%. Fortunately, there are two ways you can withdraw your retirement funds without penalties or paying income taxes. You can take out a 401(k) loan or rollover into a new 401(k) called ROBS which means rollovers as business startups.
A rollover for business startups is used to fund the purchase or growth for a small business. Small business owners must create a C-corporation and create a 401(k) for it. Then, the business owner’s rollover assets they have in other 401(k) accounts into the new one for the business. This is a great financing option because it is the only option that does not have penalties, extra interest charges, or accrues taxes.
With ROBS, you do not have to repay monthly after you roll over a 401(k) and is not considered a withdrawal from your 401(k). You also do not have to repay any of the rollover 401(k) funds even if your business fails.
One of the biggest differences between a ROBS and a 401(k) loan is that with a ROBS the minimum you need to take out of your retirement account is $50,000 and the maximum amount you can borrow is $50,000 with a 401(k) loan.
A ROBS is the best option for 401(k) financing if you have more than $50,000 in a 401(k) or IRA. The following qualifications are required for a ROBS:
If you need less than $50,000 and plan to stay employed, a 401(k) is the right option for you. You are charged interest with this loan but since you are borrowing from your own retirement plan you are paying the principal and interest back to yourself.
A 401(k) loan is the best option for you if you have the following:
Now that you have a better understanding of how you can use a 401(k) loan for financing your business, it is up to you to decide which one is the best option to either start your up business or continue growing it.