THE BLOG
09/12/2014 02:18 pm ET Updated Nov 11, 2014

How to Fund Your Business with 401K

Raising startup capital is a daunting task. Most entrepreneurs have to use their personal resources to fund their new businesses. In addition to tapping into home equity or using the cash in your savings account, did you know that you can use your 401K/IRA savings to fund your business without paying any tax or penalty? Here is how it works.

Basically, you would make an investment in your new company from your 401K/IRA account. The investment is in your new company's corporate stocks. This is equivalent to investing in public stocks, but instead of buying shares of Coke or Apple, you buy shares of your New Shiny Company. You don't have to pay back the amount to your 401K account because it's structured as an equity investment (versus a loan). You are effectively using your 401K savings as if it's from a regular savings account to fund your business.

This all sounds great, but there are a few caveats. First, you have to set up your company as a C-corp, which means you won't be able to pass through the business loss to your personal tax returns like an S-Corp or an LLC. This can increase your overall tax bill if you have other income sources.

Second, it is costly to set up your retirement plan to invest in private companies. You can hire a lawyer to do it but it would be prohibitively expensive ($15K+). Fortunately, there are a few companies who specialize in this. Most notably: Guidant Financial and Benetrends. They charge $5,000 for the initial setup and $2,000 per year for administration. It's still expensive. However, if you have a large balance on your 401K account, say $200K, the overhead will be similar to getting an SBA loan.

Finally, keep in mind this is your retirement savings. As you know, 8 of 10 businesses fail. If your company becomes one of those 8, you will lose your retirement savings along with your failed business. It can be doubly painful. Your 401K is a resource you can tap into to fund your new venture, but make sure you have a really solid business plan before betting your retirement funds on your New Shiny Company.


Learn more about business financing options on Fundastic.