Expert Tips: Investing Retirement Savings to Start a Business

June 12, 2008 By Mary White

Brett Wilder, Certified Financial Planner™ and author of The Quiet Millionaire shares his expertise with American Small Business News readers who are thinking about using the funds in their retirement savings accounts to start or purchase a business.

If you’re thinking about tapping into the hard earned funds in your 401(k) or other retirement account, pay close attention to Wilder’s advice before making your final decision:

Tips from Brett Wilder:

Everything possible should be done to seek sufficient financial capital for business purposes from sources other than retirement savings. Using money from retirement plans to start a new or buy an existing business can be very costly and cause devastating financial hardship. Therefore, it should not be done without first knowing whether the risks can be offset by the rewards of owning a successful business which will hopefully end up producing a better return and accumulating a larger amount of money for retirement.

Moreover, lack of capital is one of the main reasons why new business ventures fail so a cash flow projection as part of a written comprehensive business plan must show that the amount taken from the retirement plan will adequately fund the business operation as well as get a better return.

When money is withdrawn from a retirement plan, the Federal, state, and local income tax consequences as well as an under age 59 ½ early distribution penalty (10%) will severely diminish the net amount of money available for funding the business.

However, there is a little-known way permitted by the IRS to fund a business using money already invested in a retirement plan without incurring onerous taxes and penalties, but which is tricky and should only be done with the guidance of a qualified financial advisor. Simplistically, this relatively complex process involves five basic steps:

1. Create a new, closely-held corporation
2. The new corporation establishes a tax-deferred trust and replacement plan
3. Funds are transferred from the existing retirement plan to the new trust plan account
4. The trust buys the new corporation stock
5. The business uses the cash to fund the business

Lastly, as part of deciding to risk using retirement money for fund a business, it is important that a retirement cash flow projection be also done to determine the consequences and what it will take to recover from the possibility of losing all the money invested in the venture. According to the Small Business Administration (SBA), fifty percent of all new businesses fail in the first year and ninety-five percent fail in the first five years. So, be wise and not frivolous about using your retirement money.

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