Many individuals would like to go into business for themselves, but they lack the capital to get started. This is especially true if they are trying to purchase an existing business or get into an established franchise brand. These options typically require at least a six-figure investment, which is beyond the reach for a lot of aspiring entrepreneurs.
There is a way to finance a business purchase that you may not have thought of: using your IRA or 401(k) retirement account to obtain the necessary capital. There are a few different ways that you can approach this:
Table of Contents
- Take a Taxable Distribution From your IRA/401(k)
- Take Out a /401(k) Loan
- Set Up a Rollover for Business Startups (ROBS) Arrangement
- Interested in Purchasing a Business? Contact a Local Business Broker
Take a Taxable Distribution From your IRA/401(k)
Retirement account holders are always free to take a distribution from their account to access the necessary capital to start a business or for any other use. The main drawback, of course, is that you will have to pay taxes on the distribution amount, as well as a 10% early withdrawal penalty if the distribution is taken before the age of 59 ½. If you have a Roth IRA in which you have already paid taxes on the earnings that went into the account, you will just pay the 10% penalty.
Table of Contents
- Take a Taxable Distribution From your IRA/401(k)
- Take Out a /401(k) Loan
- Set Up a Rollover for Business Startups (ROBS) Arrangement
- Interested in Purchasing a Business? Contact a Local Business Broker
Take Out a /401(k) Loan
Your 401(k) plan might allow you to take out a loan to obtain at least some of the capital you would need to become a business owner. With this option, you are essentially borrowing from yourself, and repayments go back into your account. The IRS allows 401(k) account holders to borrow up to 50% of their plan account value or $50,000, whichever is lower. The benefit of using this option is that you can usually get a substantially lower interest rate than if you took out an unsecured loan, and this type of loan does not require an extensive credit check. The main drawback is that if you leave your job before paying back the loan, the outstanding balance is usually due within a fairly short period of time.
Set Up a Rollover for Business Startups (ROBS) Arrangement
One creative and somewhat controversial way of using an IRA or 401(k) account to help finance the purchase of a business is the Rollover for Business Startups (ROBS) option. With this arrangement, funds from eligible 401(k) and IRA accounts are rolled over and invested into a new business or franchise or used to buy an existing business. To set up a ROBS arrangement properly, however, certain specific steps must be followed. These include:
- A C Corporation that allows shareholders is formed, and a new 401(k) program is created for the company.
- The proceeds from the owner’s existing retirement account funds are rolled into the new 401(k) plan.
- The rollover funds are used to purchase stock in the newly formed corporation.
- The proceeds from the stock purchase are used as startup capital for the new business or to fund the purchase of an existing business.
Only tax-deferred retirement accounts are eligible for conversion to a ROBS. Roth IRAs and Roth 401(k)’s cannot be used for this type of arrangement. You will also need to have sufficient funds in your retirement account to set this up, typically at least $50,000. In addition, the account holder must become an active employee in the business and draw a salary; and if the business has employees, the owner might be required to offer those employees the opportunity to participate in the company retirement plan.
Although the ROBS arrangement is an alternative approach that can work well for many aspiring business owners, there are some potential drawbacks. First off, you will need a qualified firm to properly administer the plan, which will mean paying administrative fees.
Secondly, your business must operate as a C Corporation rather than as a sole proprietorship or limited liability company (LLC). This might mean having an entity structure that is not a great fit for the type of business you are getting into. Finally, ROBS arrangements have been known to come under greater scrutiny by the IRS, and setting one up could increase the chances of an audit.
Interested in Purchasing a Business? Contact a Local Business Broker
Perhaps the biggest potential drawback to using your IRA or 401(k) account to fund a venture like this is the risk that you could lose those funds and set your retirement plans back significantly if the business does not make it. But you can mitigate this risk by getting into a business that is already established and profitable. And you can increase your chances of success even further by finding the right existing business to fit your passions and skill set.
The best place to start in your search for the ideal business is to speak with an experienced CPA and accounting practice broker in your local area. Also known as business intermediaries, business brokers specialize in matching buyers and sellers, and they have helped turn many prospective buyers into successful business owners.
