Entrepreneurs starting a new business sometimes turn to their 401(k) retirement savings as a source of capital when other options are exhausted. Here is an overview of how it works, potential benefits, and risks to consider.
The Process
To access 401(k) funds, the business must first incorporate and set up a corporate 401(k) plan. Then the personal 401(k) can be rolled over into the corporate plan without tax penalties. The business owner can direct the new 401(k) to purchase stock in the company. These funds then become available as working capital.
For example, an entrepreneur rolls their $100,000 personal 401(k) into a new corporate plan. The corporate 401(k) uses $80,000 to buy private company stock. Those funds can now be used to cover business expenses.
Potential Benefits
- Provides business capital when other sources are tapped out
- Avoids taxes and penalties by rolling into a corporate 401(k) first
- Company stock purchased can be resold back to the 401(k) later
- If successful, the 401(k) can be replenished from business profits
Risks and Drawbacks
- If the business fails, retirement savings are depleted
- Complex setup often requires expensive professional help
- Ongoing compliance and administration costs
- Limits future tax-advantaged retirement contributions
- Locks up funds until at least age 59.5
Given the risks involved, financial advisors generally recommend exhausting all other funding sources before using retirement funds to start a business. Thorough planning and analysis is crucial to determine if the potential rewards outweigh the downsides.