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Starting your own business is an exciting journey. It starts with an idea and before you know it, you’ve developed your rough draft of a business plan into a successful venture. Of course, that doesn’t mean it’s been an easy journey. There are wins and setbacks, but a solid business model and persistence can bring both personal and financial rewards to a startup entrepreneur.
One of the most common challenges small business owners face (and something that can either maim or kill a company) is where to get initial financing. In this article, we discuss how to use your retirement plan to meet business needs, as well as the pros and cons of doing so.
What is a retirement account and how do they work?
Before jumping into the details of financing a small business with a retirement account, we must first review the basics. retirement plans, Most individuals are looking forward to the day when they can stop punching the clock at nine to five and spend their golden years doing what they love with the people who matter most. To afford that dream, they rely on their retirement funds to cover the cost of living.
The most popular retirement accounts are the 401k and the Individual Retirement Account (IRA). Both types of retirement plans allow individuals to contribute money over time, earn additional money through working and investing, are managed by a plan administrator, and receive interest income on their plan balance. Huh. One of the best parts about these investment accounts is that the profits and Dividend Earned are tax free. In addition to earning tax-free, contributions made to the account are usually tax-deductible.
Retirement savings accounts can be classified into those offered by employers and those not offered by employers. Typically, investors consider employer-issued retirement accounts to be 401k accounts and do not offer the same place of employment as IRAs. However, each category has multiple Types of Retirement Savings Accounts,
employer offered retirement accounts
many jobseekers consider employee benefits While looking for your next employer. Retirement plans are often incorporated into a robust benefit plan. Traditional plans, such as a 401k, typically work when the employee chooses to contribute a flat rate or percentage of each paycheck to the account. Some plans also allow the employer to make additional contributions on behalf of the employee. The terms of the matching contribution depend on the employer’s specific benefits package. While the most popular type of retirement plan offered by employers is the 401k, there are many plans that your employer may be involved in, including but not limited to the following plan types.
- 401k – Can be funded by employee and employer, contribution is made from employee’s earnings, limited investment options for employees to choose from
- 403b Funded by employees through deductions from their paychecks, employers can also contribute, offers little investment option
- simple ira – Funded by employee and employer with higher penalties for early withdrawal
- profit sharing plan Contribution made by the employer to the employee on the basis of net profit of the business (higher limit as compared to other plans).
Retirement plan not linked to an employer
Finding a career where your company offers a 401k isn’t the only way to have a retirement savings account. Other retirement accounts, such as those listed below, offer individuals the option of rolling over 401k from former employers or opening a new retirement account.
- traditional ira Tax-deductible contributions by the individual cannot be withdrawn without an early withdrawal penalty before the investor reaches age 59.5
- Roth IRA – Tax-free distribution but available only to individuals earning income
- payroll deduction ira – Contribution is made automatically from paycheck, does not allow loan on balance
- guaranteed income annuity – Expensive savings plan that is not linked to stock market performance
How to use your retirement account for business purposes
For entrepreneurs who are concerned about the pitfalls of borrowing money from a third-party lender to finance a startup, a suffrageor invest in an established business using retirement savings A common choice for business funding options. There are three ways to use a retirement plan to cover business expenses, including taking a retirement plan loan, taking a distribution, or setting one up. Rollover as a Business Startup (ROBS) Account.
Taking a loan from your retirement savings account works like a traditional business loan from a lender, in that it must be repaid according to repayment terms that will include the interest rate. IRAs don’t allow loans, but most 401k and 403b plans allow investors to borrow the lesser of half of their vested balance, or $50,000. The loan is issued by the plan provider and repaid by the employee’s additional contribution. If a person leaves their employer or savings scheme, they will need to repay the loan in full at that time.
Some entrepreneurs choose to take distributions from their retirement plans because the process is simpler than a 401k loan. The major advantage of taking distributions to finance a business is that the money is not required to be repaid and there are no restrictions on the use of the money. Disadvantages of taking distributions from a retirement account include penalties and income taxes due for withdrawing from a pre-tax plan.
r o b
Rollover for Business Startups (ROBS) is a unique program where individuals can use the entire amount in their 401k or IRA account to cover business costs. ROBS are a more popular option for financing businesses because the funds are not taxable and withdrawals are penalty-free. To use the ROBS scheme To Finance a new or existing businessThe following steps should be taken.
- Structure your new business as a c corporation (C-Corp) Other organizational structures such as an LLC or S-corporation will not work for the ROBS financing option because they do not allow shares of the business to be sold.
- Set up a new 401k plan for business – The ROBS plan allows the 401k plan to invest assets in a new, privately held, C corporation. It is recommended that you consult with an investment firm or private placement custodian to ensure that the 401k is set up to purchase stock.
- Process direct rollovers from existing retirement accounts to the new plan – An investment advisor can help you move money already held in an employer-run 401k or IRA into your new retirement account.
- Use 401k Balance to Buy C-Corp Shares – The total funding amount available to your new business is based on the ownership percentage provided with the new 401k plan, so the plan must be 100% owner-owned if the plan is the only source of funding.
- use the capital from the sale of stock to fund the new business Once the shares of the new corporation are purchased, the money will be transferred from the retirement account to the business checking account.
Advantages of Using Your Retirement Account to Fund Your Small Business
Like every business decision, there are advantages and disadvantages to using your retirement plan to finance your new business. If you’re considering whether your 401k or IRA is the right source of business funds for your new company, consider the following benefits of using a retirement account to cover startup costs.
- No Lender Eligibility Requirements An alternative way to obtain the capital needed for small business financing may be a loan from a bank, credit union, or alternative lender. However, getting accepted for a short business loan This means meeting the lender’s eligibility requirements, which may include a good credit score, steady annual revenue, a sizeable down payment, and two years of business operation.
- no penalty or tax Using a ROBS plan to finance your small business means you won’t have to pay IRS income tax on distributions or early withdrawal penalty fees from an IRA.
- no monthly payment – Since no repayment is necessary when financing a business with retirement savings, there will be no impact on the monthly cash flow of the new business. A greater portion of the company’s profits can be used to grow the business instead of paying down debt or paying off credit card debt.
The Downsides of Using Your Retirement Account to Fund Your Small Business
as it is risky Use personal savings to start a businessThere are similar cons to using your retirement account to fund your new business. Before forming your new C corporation or calling your 401k plan administrator, consider the following pitfalls.
- If the business fails, you could lose your retirement money. Investing your entire retirement account in a business means that if the business doesn’t make enough profit, the nest egg you worked so hard for will be gone.
- Setting up a C Corporation – while you can choose separately types of business structuresCorporations are usually reserved for large businesses due to the corporate tax implications.
- no more account profit When you use income from an IRA or 401k plan to finance a new business, the retirement account balance is depleted or reduced. There is no potential for the funds to earn further investment income.
- out-of-pocket fees Setting up a ROBS account and a new 401k will involve an initial fee paid to the administrator along with a monthly fee to manage the plan. The fee cannot be withdrawn from the Basic Retirement Fund.
Alternative financing options for small business owners
If you don’t want to risk your retirement money to finance your new business, considering loan options from a bank, online lender, or other financial institution may be a more attractive option. If you are seeking funding for a new or established business, consider the following Types of Business Loan Options,
One sba loan A type of business financing where a portion of the money is guaranteed US Small Business Administration, SBA loan programs provide low-interest, long-term financing for entrepreneurs. Because a percentage of the loan is backed by the government, SBA loans often require a lower down payment than other types of loan options.
Term loan A traditional type of financing where the borrower receives a lump sum of money upfront and repays the loan with monthly payments of interest and principal. Repayment terms can be long term or short term and the interest rate and other financing costs are determined by the creditworthiness of the lender and borrower.
If your startup plans include a large purchase such as a building, storefront, equipment or machinery, a specialty loan may be the right loan option for you. Specialty Loans Include equipment financing And commercial real estate (CRE) loan,
It is possible to finance a new business or existing business with money from your retirement account if you take a 401k loan, request an early distribution, or start an ROB plan. The advantages of this type of financing include not meeting any approval requirements or making any monthly loan payments, but the disadvantages of using retirement money for a business include the risk of losing your personal savings, a c Starting a corporation and paying setup fees. An alternative way to finance a business is to take out a term loan, SBA loan, or specialty loan with a lender, such as Biz2Credit, Biz2Credit’s experts have helped countless entrepreneurs find their startup financing, such as Victor AlcazarJoe was able to borrow $20,000 in just four days’ time.