Tips for using your current retirement fund to start a business

Now is an excellent time to start your own business. The world is far more connected than at any other time in history — this opens you up to a potential global audience of consumers, not to mention access to knowledge and advice from successful entrepreneurs through your social media channels.

Yet, one issue that persists for any startup is understanding how you can actually go about funding it.

Capital can be hard to come by, particularly in uncertain economic times. However, one option many people overlook is the potential of their retirement savings. You might think that this is a rash move, particularly if you’ve built up enough that your retirement is now all set, but many people are taking the view that this is another way to positively invest those funds toward a brighter future.

Let’s review some tips that can put you on the most positive road to utilizing your retirement assets, along with some key aspects that it’s important to consider.

Weigh the Risks 

Before you dive in and start using your hard-earned retirement savings to start a business, it’s important to gain a better understanding of what you have at your disposal. If you’ve been employed for a while, you are likely to have a 401(k) — this is the retirement savings account that your employer will have contributed to.

Although, Colorado recently passed a law that required employers to put a percentage of workers’ salaries into an auto-individual retirement account (IRA) unless the worker opts out, so you may have one of these too.  

Both of these plans are designed to accrue non-taxable interest to provide you with a retirement fund, and both can be withdrawn from. If you’re over 59 ½ years old, you can usually do this without any problems and utilize as much of the value toward your enterprise as you’d like to. However, if you’re under 59 years old, you’re likely to incur penalties if you withdraw from your 401(k) — the Internal Revenue Service (IRS) takes a significant chunk of your savings.

 You’re able to roll over funds from one retirement account to another without such issues, and you’ll still retain your compound interest. When you withdraw, you have immediate access to some of your funds, but with tax penalties and loss of interest, it may not be as much as you might think.  

As such, some entrepreneurs utilize a method in which they create a corporation and then start a profit-sharing retirement plan for that corporation that allows 401(k) funds to be used to buy company stock. This lets you roll over your previous 401(k) to the new company plan and immediately invest it in stock, providing you with capital.

It’s more complex, but it can help you avoid the losses you are likely to incur by simply withdrawing. There are still risks involved, but it gives you another option to consider.  

Don’t Rush Into It 

One of the dangers of utilizing your 401(k) or IRA is that it can very much appear as though you have this little treasure trove of cash at your disposal. However, you also have to bear in mind that these are future pension funds, and while you are free to put your retirement money wherever you wish, withdrawing everything at once can be something of a gamble — you’re betting a certain amount of future financial stability on your ability to create a successful business. On top of that, there’s a fair amount of misguided information circulating regarding pension plans and the transfer and use of them. Therefore, it’s important not to rush into a withdrawal and treat the situation with the seriousness it warrants.   

Take time to research your options. Different retirement plans have different rules, and your ability to withdraw from a 401(k), in particular, can depend on the plan your employer has put in place. Rather than lose your retirement fund entirely, you may be able to take out a 401(k) loan against it.

In the case of an IRA, if you’re under the age of 59 and don’t need a lump sum to start your business, you may find it more prudent to arrange substantially equal periodic payments (SEPP), which see you receiving your funds in smaller, regular amounts and also avoiding withdrawal penalties.    

If this sounds like a complex situation, the truth is that it certainly can be. This is why one way to avoid making mistakes is to get advice from your employer or fund provider’s benefits manager.

These are professionals who have the expertise to navigate the legal and taxation aspects of your retirement fund, and in some cases may even have had a hand in creating the company benefits scheme you’ve been paying into.

As such, they are best qualified to give you impartial advice on the status of your fund and clearly communicate what your options are. They are a useful resource, and it’s worth utilizing them before making any decisions.   

Make a Solid Plan 

A good business plan is essential for any enterprise. But the imperative is perhaps more pronounced when you are planning to use your retirement funds for your own capital. After all, the biggest risk here is your business could fail and you’d be left with no retirement nest egg. Therefore, you’ll want to make sure that your business plan is as watertight as possible.  

Really consider whether your startup needs the bulk of your retirement savings immediately. Review what elements you’ll need to invest in, and see where you can minimize, or take your initial growth in stages.

This may make it more practical for you to withdraw a small amount (either directly or following a rollover) from your fund initially and leave a portion of it intact. One of the primary areas you need to focus on in this case is your cash flow.

Create a plan that gives you a framework to invest your minimal withdrawal and how the income you generate can go toward funding the next phase of your growth, rather than relying on another withdrawal from your fund.

This treats the remainder of your 401(k) or IRA as a backup, rather than the primary source of capital. 

New businesses need capital, and one of the options at your disposal is your retirement fund. However, it’s important to gain a full appreciation of the risks and methods involved and seek professional advice where needed.

It’s a big decision, but with some careful planning and good research, it can help make your entrepreneurial ambitions a reality.