Should I Finance My Business With My 401(k)?

Rieva Lesonsky

Rieva Lesonsky

Contributor at Fundera
Rieva Lesonsky is a small business contributor for Fundera and CEO of GrowBiz Media, a media company. She has spent 30+ years covering, consulting and speaking to small businesses owners and entrepreneurs.
Rieva Lesonsky

Since the “Great Recession” of 2008, financing a business has become more challenging than ever, especially if you don’t have a track record as an entrepreneur. For entrepreneurs who are desperate for startup cash, the question, “Should I finance my business with my 401(k)?” might come up. And when you start to weigh your options, taking a 401(k) loan from your retirement savings may start to sound like a smart idea.

There are two ways you can use a 401(k) to finance your business: 1) by taking out a 401(k) loan and 2) by rolling over your balance into a new 401(k) plan, called a ROBS. Both will come with their own pros and cons, and some of those cons are pretty significant. So, if you’re looking for a simple answer to the question, “Should I finance my business with my 401(k)?”—the answer is probably, “No.”

Both options for financing your business with your 401(k) will come with the inherent risk of losing both your business and your retirement nest egg. As a result, we suggest looking to any other option you have to finance your business before resorting to your 401(k).

That said, if you don’t necessarily have other options beyond using your 401(k) to finance your business, you’re going to want to know what you’re doing. So, with that said, let’s take a look at your two options for ways to finance your business with your 401(k).

401(k) Loan

If your 401(k) plan allows loans, the IRS permits you to borrow up to half of your vested balance, or $50,000, whichever is less. Be sure to check with your plan administrator; some plans restrict what borrowed funds can be used for.

Pros:

  •      401(k) loans typically have lower interest rates than many other types of business loans.
  •      You may feel better about paying yourself back vs. being indebted to a third party.

Cons:

  •      The interest rate of a 401(k) loan isn’t the only factor to consider. You’ll also need to pay:
    • Loan fees such as origination and administration costs.
    • A 10 percent penalty for withdrawing the retirement funds early (if you’re under age 59 ½).
    • Income tax on the entire balance of the loan if you fail to pay the loan back within the loan term (generally five years).

ROBS

To avoid the 10 percent early withdrawal penalty, some startup entrepreneurs use a different form of 401(k) financing known as a Rollover-as-Business Startup (ROBS). Here’s how it works:

You create a C corporation that sets up its own 401(k) plan. Then, you roll over the funds from your existing 401(k) into the new company’s 401(k). (Since it’s a rollover, not a distribution, you pay no taxes or penalties.)

Your new corporation issues stock, the new 401(k) invests in the corporation by buying its stock, and the money used to buy the stock becomes a source of capital for the new corporation. (One catch: You can’t pay owners’ salaries from these funds.)

Pros:

  • You avoid paying taxes and penalties on the money you use to start your business.

Cons:

  • Do ROBS sound too good to be true? The IRS thinks so too, and keeps a close eye on ROBS, which it has called “questionable.” You’ll need to enlist a company experienced in setting up ROBS to get you through the process, and to ensure continued compliance going forward so you don’t get hit with an audit or penalties. These costs quickly add up.
  • You now have the headaches of administering a 401(k) plan, including educating employees about the plan and allowing them to participate.

The big “con” of either 401(k) financing option is that if your business fails, you could lose both your company and part—or all—of your nest egg. Is that really worth the risk? Personally, we recommend trying every other tactic under the sun before you even consider this one.

Your Top Alternatives to Financing Your Business With Your 401(k)

So, now that you know the intricacies of your choices for financing your business with your 401(k), you can see for yourself that neither of these options is particularly ideal. As a reminder, we suggest that you sift through all of your other business funding options before you decide to dip into your 401(k) to finance your business.

You might be wondering which financing options are your best alternatives to financing your business with your 401(k), and the answer to this question will be different for every business owner. That said, there are two business financing sources that will generally be a business owner’s best bets when it comes to finding a less risky source of funding than their 401(k). Let’s take a look:

Business Loans

Now, you may be wondering “Should I finance my business with my 401(k)?” simply because you’re underestimating the business loan choices you could potentially access.

Whether your business is just starting out or your personal credit is less-than-stellar, there’s likely still a business loan financing option out there for you. From secured financing options—like invoice financing and equipment financing—to short-term options—like a short-term loan or a business line of credit—business loans can come in all different shapes and sizes, some of which are surprisingly accessible to business owners.

At the end of the day, even though opting for a business loan means you’re taking on debt, you’ll still likely be able to find a much better financing option than dipping into your 401(k) if you consider all of your potential business loan products.

0% Intro APR Business Credit Cards

On the other hand, you might be considering financing with your 401(k) simply because your business is just too new to qualify for a loan.

Well, we’ve got good news—one of the very best ways to finance your business—a 0% intro APR business credit card—is also extremely accessible to businesses with little-to-no business history.

How does it work, you ask?

First off, business credit cards are an ideal funding source for new businesses because their qualification criteria almost always rely on personal credit rather than the business’s credit history. As such, new business owners with good personal credit will be able to access some of the very best business credit cards on the market.

One top-of-the-line perk new business owners will be able to access with a business credit card is a 0% intro APR period. This feature is exactly what it sounds like—a few months right after account opening in which any balance you carry on your card will have a 0% APR on it. As long as you make your monthly minimum payment on time every month, you’ll be able to carry an interest-free balance from month-to-month during a 0% intro APR period.

Essentially, 0% intro APR periods make your business credit card work like a free loan. With this feature, you’ll be able to pay down a big purchase gradually, without accumulating a cent of interest.

Sounds pretty nice, right?

If you think a 0% intro APR card is the perfect alternative to financing your business with your 401(k), then we suggest you look into the American Express Blue Business Plus. With a 15-month 0% intro APR period, this business credit card offers the longest no-interest intro period available on the market. Plus, as you spend you’ll earn rewards points at 2x for the first $50,000 you spend every year.

On top of it all, you won’t have to pay an annual fee to access the Blue Business Plus, so the best 0% intro APR card on the market could be yours for free.

The Bottom Line for Financing Your Business With Your 401(k)

As mentioned, the short answer to “Should I financing my business with my 401(k)?” is basically, well, “No.”

Finding another source of business funding other than your nest-egg will not only end up being more efficient and prudent for your business but will also relieve you of the pressure in running your business that financing with your 401(k) could impose.

Not to mention, if you opt for another source—like business loans or business credit cards—you’ll also avoid multiple legal hurdles that financing with your 401(k) would entail.

All in all, generally speaking, financing your business with your 401(k) ought to be considered a risky last resort rather than a front-running option. Luckily, there are many, many options for business owners old and new to seek financing from.

Resources

  • Guidant Financial and Benetrends are two financing firms that help entrepreneurs set up ROBS.
  • Bankrate has a calculator you can use to figure out the true cost of borrowing from your 401(k) plan.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.
Rieva Lesonsky

Rieva Lesonsky

Contributor at Fundera
Rieva Lesonsky is a small business contributor for Fundera and CEO of GrowBiz Media, a media company. She has spent 30+ years covering, consulting and speaking to small businesses owners and entrepreneurs.
Rieva Lesonsky

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