It always comes back to money, doesn’t it? You have a dream of starting your own business but looking at your bank account balances reminds you that in this case your dreams may be larger than your wallet. Some businesses may require very little in startup funds while others may take millions of dollars.
Likely, the business you want to start or purchase will be somewhere in the middle but before you can sign the papers, you have to find the money. Some people tap their 401(k) but is that a good idea?
IRS rules don’t allow you take money from your 401(k) without penalty until you reach the age of 59 1/2. If you do you have to pay income taxes plus a 10% penalty along with losing the compounding effect you receive from having the money in the account gaining interest and value. If that doesn’t make sense to you, remember that taking money out of your 401(k) prior to age 59 1/2 costs you a lot more than just the amount you withdrew.
Sometimes, through a complicated maze of converting 401(k) assets in to an IRA and going through other legal and financial hoops, you can use your 401(k) assets to fund your business startup without paying the penalty but that’s a risky strategy.
Paying interest on a bank loan or giving up some control of your company in order to gain investor funding is a cost that is tough to swallow for new entrepreneurs with little cash flow. Using your 401(k) assets may remove all or much of those liabilities.
Some investors are more comfortable putting their investment dollars to work in businesses they control instead of placing the funds in to Wall Street investment vehicles that may rise or fall at will.
The largest and most important negative to this strategy is your potential for loss. If you were to only use investor funds or bank loans to fund your startup, the most you’re going to lose is your business. Since registering your business and following appropriate laws shields your personal assets from your business losses, the worst that would likely happen is that you lose the business.
If you use retirement funds, not only would you lose your business, you would lose the funds you were planning on using to fund the years when you can no longer work and that can be catastrophic.
No article can tell you what is appropriate for your situation but in general, using your retirement funds for your business comes with too much risk. If you can’t find the funding from any other source, rework your plans but finding small business funding may be easier than you think.