401(k) Business Financing Guide
If you’re one of the millions of workers who has been laid off since the start of the Great Recession, you might be thinking about starting your own business, or buying into a franchise opportunity, and wondering where you can get seed capital.
If your retirement account hasn’t been decimated by plunging stock market values, it could make sense to tap into your 401(k) to start your own business — and if you do it right, you can avoid tax penalties for using that cash.
Assuming you’ve thought long and hard about what business you’re best suited to, and identified a need and a niche, what you’re looking for is cold, hard cash to set up your office, or to buy equipment or tools.
And while 401(k) self-funding allows you to maintain complete contol of your business, and not have to answer to anyone about how you spend the money, you should remember that you’re gambling that you’re going to get a better return from your business than you would get from the stock market. If you gamble and lose, it could affect when (or even whether) you can retire.
So after all the words of caution you still need to make sure you do things the right way to avoid penalties. They’re easy enough to follow, but a little more complicated to implement.
Here’s how you do it:
1. Establish a C corporation that has created, but not issued, stock.
2. Adopt a retirement plan for the corporation. This is important: get a profit-sharing plan that allows 100 percent of the plan assets attributable to rollovers to be invested in employer stock.
3. Rollover your retirement funds from your previous employer or IRA into the 401(k) plan for your new corporation. You can do this for any and all investors in the company who want to use their retirement savings. Spreading around the cost will dilute your share of the business, but it will also reduce your risk of losing everything if the business fails.
4. The corporation issues all of its stock and transfers it to the new profit-sharing plan in exchange for the cash in the plan.
And now your corporate bank account should have the funds from its investors available to spend on whatever your business needs.
While the steps look easy enough to follow, there are laws which must be adhered to, may of which can be found in the Employee Retirement Income Security Act (ERISA), so the person or people who guide you through this set-up process should have some experience with forming corporations and ERISA regulations. If you miss something, or make a mistake, there are ERISA and tax code penalties that you could expose your business and investors to.