Starting a small business is a dream that many people have. While there is certainly a risk of failure, the benefits of success are many. It is possible to make much more money working for yourself rather than for someone else and you will have the satisfaction of doing something you love.But a lack of money holds many would-be entrepreneurs back. Fortunately, there is a way out for those who have accumulated funds in their IRA or 401(k) while employed. It is possible to access these amounts to start your new venture.
You need expert advice
Do not make the mistake of trying to withdraw the amount lying in your retirement funds on your own. It is essential that you take the help of a financial planner or third-party retirement-plan administrator.
The correct procedure is to set up a C corporation (a corporation that is taxed separately from its owners) and establish a corporate retirement account. After this, the funds in your IRA or 401(k) can be transferred into this account.
Subsequently, the funds in this corporate account can be invested in the stock of the business that requires funding.
This four-step method requires a professional to set up the new company and create the required retirement fund. If there is a procedural error at any stage, it is likely that the Internal Revenue Service will ask you to pay taxes on the money you use. You may also be liable to pay an early-withdrawal penalty.
It's an expensive process
Be prepared to pay fairly hefty sums for accessing your own retirement money. A reputed firm will charge you about $5,000 as a flat upfront fee in addition to yearly charges totaling about $1,000 to set up the plan that allows you to invest into your business.
If you have several hundred thousand dollars in your IRA account, it may be advisable to go through the process of setting up a new corporation and then creating a 401(k) plan to get at your retirement money.
But if the total of your retirement funds is less than, say, $50,000, it may be simpler and more economical to withdraw money directly from your IRA balance and pay the required tax. You can pay yourself a salary
As an employee of your new company, you can draw a salary. But this money must come from the operational revenues of your new business.
If you draw salary directly from the money that has come from the sale of stock it would be likely to create complications with the IRS and result in a tax liability.
You need to exercise caution
Bear in mind that you will effectively be financing your new business with the funds that you had set aside for retirement. If your new venture does well and earns substantial profits, you can probably afford to allocate an even greater sum for your sunset years.
But if your business fails, you could be left without any funds to fall back upon. It is useful to keep in mind that according to the U.S. Small Business Administration, half of all businesses do not survive beyond the first five years.
It is certainly possible to use your IRA or 401(k) funds to finance your new business. But you should try to get finance from a bank or finance company and only use your retirement funds as a last resort.