If you have a retirement fund, a 401 (k), an Individual Retirement Account (IRA), or some other form of retirement or pension, you may be in business. Not only do you have a good chance of pulling together the capital you need for your business, but you may be able to do so fairly quickly and easily.
Many employers offer retirement plans to their employees. The most popular of these plans are known as 401(k) plans. A 401(k) plan enables you to make contributions from your pretax earnings to your own retirement account. In many cases, the investor’s employer matches his or her contributions, and many plans allow the investor to direct where the investment goes ‘” into a specific stock mutual fund or other formal investment program.
With a 401 (k), you have two options for obtaining the capital you seek.
Withdrawing cash from your 401 (k)
In the first option, you can simply withdraw the cash you want in the form of an early withdrawal. There are a couple of problems with this approach, however:
- When you withdraw the funds, you may incur ‘” subject to your age ‘” an early withdrawal penalty (10 percent of the total amount of money withdrawn), and the money will be considered taxable income in the tax year you withdraw it.
- The funds you withdraw will no longer earn you money as an investment, with interest compounding over time. There is no guarantee, of course, that the investment into which you sink this money (your business) will experience a comparable rate of return.
Using your 401 (k) to get a loan
In the second option, you can obtain a loan against your 401(k) account. This approach is generally preferred to an early withdrawal because you aren’t required to pay the 10 percent penalty, nor are the funds counted as taxable income. You do, however, have to pay interest on the loan, just as you would on any other loan. And one more thing: if you quit your job to start your new business, you may or may not be able to keep your 401(k) account (and your loan) active with your old employer. Be sure you’re familiar with your company’s policies on 401(k)s before you quit, not after! Here are some key guidelines for 401(k) loans:
- The interest rate on 401(k) loans is usually fairly low ‘” perhaps just a bit over the prime rate (the interest rate charged to their very best and most creditworthy customers).
- You must repay the loan in full within five years. Repayments are generally made through payroll deductions.
- Loans are limited to 50 percent of the total value of the 401(k) investment account balance, up to a maximum loan of $50,000.
- Termination from your firm ‘” whether you quit or are fired ‘” may mean that you’ll have to repay the loan immediately (some plans do allow you to continue the loan as long as you continue to make payments ‘” check with your employer to be sure). If you fail to do so, the loan will be treated as an early withdrawal, you’ll be required to pay the 10 percent penalty, and the funds will be considered taxable income.
While this article focused on 401(k) retirement plans, there are many other forms of retirement and pension plans in use by businesses today. Some of these other retirement and pension plans may have similar provisions as 401(k)s, allowing you to take early withdrawals or loans. Check with your plan administrator to find out what your options are.
For many businesspeople, 401(k) retirement plans are a source of capital that makes sense. It’s your money, after all ‘” why not put it to work for you now rather than later? If you’re seriously considering putting the money in your account to work now, keep these things in mind:
- In most cases, you won’t be able to make a phone call and have the cash from your retirement account an hour or two later. It may take several weeks for your plan administrator to process your request and cut you a check. So the sooner you need the cash, the sooner you need to initiate your request.
- If you decide to make an early withdrawal from your tax-deferred retirement plan [IRA or 401 (k)], you’re going to pay a fairly hefty penalty for the privilege. Any distributions before you turn 59 1/2 are subject to a 10 percent early withdrawal penalty, as well as counted as taxable income. This may be a very high price for you to pay to obtain capital for your business. But if it’s all you have and you’re determined to make your business a success, it may be your best shot.
Tapping into your personal resources is a time-honored approach to raising capital, especially for startup enterprises. If you have the funds available and you can afford to lose them, then by all means dive right in. But if the loss of these personal funds would cause you to lose your home, throw your family’s life into disarray, and send you to the poorhouse, you’d best search for alternative sources of capital.