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Using Retirement Funds for Business Capital: Opportunity or Bad Idea?

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Using Retirement Funds for Business Capital: Opportunity or Bad Idea?

Written by Chris Martin for Gaebler Ventures

Entrepreneurs frequently have trouble raising money for the new businesses. They often wonder if they should cash in their existing retirement funds in order to obtain startup capital. Here are the pros and cons of doing that.

When many entrepreneurs are looking for sources of funding for their startup businesses, it is hard for them to ignore that large dollar figure that jumps off of their quarterly benefits statement.

Using Retirement Funds for Business Capital Opportunity or Bad Idea

If they have been employed at a traditional business for many years, they may have accrued a significant amount of retirement funds in their 401(k) plans, IRAs, or stock option accounts. They may think, "Wouldn't it be great if I had access to that money now instead of having to wait until I retire?"

And there are those who choose not to wait that long.

More and more entrepreneurs are opting to take their retirement nest eggs and roll them over into their new company. The ones who go on to business success then take some of their profits and refill their retirement accounts to replace the funds they used for startup purposes. The mechanism that allows you to tap into your retirement nest egg involves the Employee Retirement Income Security Act of 1974.

Here's how it usually works: several financial firms will, for a fee, take your 401 (k) or IRA (but not an SDIRA) funds and put them into an ERISA profit-sharing plan for your entrepreneurial venture. You don't pay any income taxes on the money, nor are you socked with early withdrawal penalties. And you have free access to that money once the transfer of funds is complete.

So what's the catch?

The most obvious one is the reduction or elimination of your nest egg for your golden years. If you blow through the capital, there's nothing left to replenish it with. You'll have to build your retirement fund back up over time. So there are some questions you should ask yourself before making this decision.

Do I have time to reconstruct my retirement portfolio?

Obviously, the answer will be different for 30-year old entrepreneurs than for those in their late fifties. And if your startup business fails to launch, you could be back where you started – without a retirement fund.

Am I comfortable with letting another company manage these funds?

If you read the Internal Revenue Service rules about ERISA accounts, you'll see just how complex and difficult to understand they are. So unless you're a financial whiz, you'll be relying other entities to help you do the necessary paperwork and file your taxes every year. They'll also be charging you to do it.

What do independent advisors think?

Independent means someone who does not have a vested interest in the outcome of your decision. So don't ask your money manager or the firm that is overseeing your ERISA account. Seek out a tax attorney, financial planner, or an ERISA-literate CPA for objective advice on whether rolling over 401 (k) funds is a good idea.

Ultimately, the entrepreneur has to weigh the pros and cons of taking what he or she has set aside for later and spending it now. It's the quintessential risk-reward enigma, and there's no easy answer. In fact, it's one of the few pivotal decisions that an entrepreneur can make that has the potential to determine whether the business succeeds or fails.

Chris Martin has been a professional writer for the last seven years. He is interested in franchises and equity acquisition.