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Hello,
I am in the process of starting a new business and recently learned about possibility of financing my startup through my 401K. It sounds like a good concept (my 401k stays in tact while I get a loan against it). Has anyone here used this method of financing? Can you share with me +/- of this type of financing?
Thanks,
Ravi
In bootstrapping your venture ... that is the last resort to go ... short of withdrawing from your 401K early.
The reason being is that when you borrow from your 401K only 50% of your "contributed amount" (not the employers matching funds) is available to be borrowed. Secondly, when you do borrow from your 401K ... those dollars are then set apart from your investment catagories and only "earning" the interest amount that you are repaying.
Thirdly, if you are terminated or quit prior to paying back the loan ... the full amount is due. If you do not repay the loan immediately, it is classified as an early withdrawal, taxed at your curent rate and a 10% penalty assessed to your account for the funds you borrowed.
In other words, last ditch effort do it. But try Grandma first. (She always believed in you anyway.)
I will admit to be new to this, but I have been researching this topic recently and there is a bit more to it TJG. What you are describing is a loan from a 401 (k). There is another way to do it, however. You incorporate a C corporation and take 401 (k) money to purchase shares in the new corporation. I am not sure if the 401 (k) money that is buying the stock is put into a new 401 (k) with the new corporation or in a self-directed IRA. I am becoming slightly more comfortable with the concept and think this may be a good way for people to access start-up money. My investment advisor friends think this is radically risky and I concede that it would probably be a very bad idea to sink 100% of a 401 (k) into a start-up, but 40% may be a more reasonable figure.
Ravi:
Some employer`s allow you to borrow from your 401k account - many do not.
As previously mentioned, if you leave the company - your loan would need to be repaid or would become an early withdrawal and be subject to tax a nd penalty. Since cash is precious - I don`t recommend "wasting" 10% on the penalty.
If you are talking about an IRA (not a company 401) :
1. You cannot borrow against your IRA funds
2. There are some "interesting" ways to use IRA funds to invest in your own business. Generally speaking, one should have $100,000 in their IRA to make this approach worthwhile.
Robert Johnson
The 401k funding option is gaining momentum in entrepreneur circles, and as a growing number of baby-boomers find themselves prematurely out of work. Companies like Guidant Financial Group offer this type of business and franchise financing with retirement funds. With Guidant, you are not taking a loan from your IRA or 401k, but investing into your business like you would with stocks of a publicly traded company. If your business makes money, your IRA/401k grows. There is risk involved, but there is also risk with debt financing, and in that scenario you are paying interest too. Here is a good article from USA today about 401k small business financing.
I don't know whether I was smart to do so, but I borrowed the max allowed from my 401K this very evening. My check should be in the mail within a few days. Starting my cafe is my future. If I make the income my cafe projects, I'll be able to put together a better future than a 401K at my current job could really offer. That, and I'm not likely to remain employed long - not by choice, but not something I'm opposed to. I could use the unemployment to get the cafe going. At the rate the allowed collection time is expanding, I'll be retirement age before it runs out. Working a day job makes starting a better job challenging, that's for sure. Anyway, I rambled. If you need money to finance a startup, and you have it in your 401K, it seems like a good deal to me.
EDIT:
I do have a question though. I'm going to make up numbers.
My entire 401K Account = 10,000
I borrow 5,000
I lose my job.
What happens to the other 5,000? I don't understand how the penalty system works. They say you get penalized on the amount of your loan. But, I would imagine that you'd receive the other half of your 401K? At least your vested allowance? If the other half disappears, while I get penalized to no end on the little bit I borrowed, that hardly seems right, but, when something hardly seems right, it's usually the case.
Matt,
If/when you leave your employer - the amount you borrowed from your 401k will, if not immediately repaid, become a distribution which creates a tax obligation for you. So you would pay taxes on that amount as "regular" income plus the penalty for early withdrawal. [This is why I generally advise against borrowing you 401k funds if you are going to leave the company]
Any vested funds still in the 401k would remain there. You could leave it with your employer or "roll it over" into either your personal IRA or the 401k of your new employer (if they have one).
Good luck with the café.
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It is a good idea to borrow money from your 401k account, But there are also some terms and condition for that. Although, the implications on 401k loans are very minimal and normally you get a long time to repay it, Following are some conditions when you should not take a 401k plan loans.
a) When you are planning to leave the job.
b) You are going to retire in a couple of years.
c) You can not contribute regular.
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