How to Start a Business With Your 401(k)

While many people would scoff at the notion of using 401(k) funds for anything other than retirement, for the entrepreneur who absolutely MUST get a business off the ground immediately, there is an option to use 401(k) funds to start a business.

There's a little known, but increasingly popular provision in the tax code referred to as the Rollover as Business Startup (ROBS). It allows someone to start up a new business venture with funds from an old 401(k) account without incurring the dreaded early withdrawal penalties meant to deter people from using their 401(k) accounts like piggy banks. Chances are, you might already have some retirement funds stashed in an IRA account as well. (See also: 4 Reasons Why a Roth IRA may be better than a 401(k))

There are various ways to structure the transaction, but if you engage an experienced and reputable accountant or tax attorney, they should be able to guide you through the recommended process for your particular situation. Given the potential complexities and tax liabilities if this isn't enacted properly, I haven't listed out step-by-step instructions. But it IS possible and legal, and thousands of Americans are doing it.

When Would Using 401(k) Funds to Start a Business Make Sense?

Tapping retirement funds for any endeavor requires careful consideration, but there are a number of plausible scenarios where one might actually be better off going the 401(k) funds route than other conventional means.

To Avoid Going Into Debt

If you're an entrepreneur who is going to pursue an idea no matter what, nothing will stop you, not even going into debt. So, rather than borrowing money at a high interest rate or using questionable means to gain access to capital (like peer lending or deferring payments from other mandatory sources) this might make more sense and keep you out of debt.

When You're Going in a New Direction

A common example in this economy might be someone who was laid off. Let's say you're a highly paid executive with a sizable 401(k) who was just laid off, and the odds of you finding work at a similar salary are quite low. Maybe it makes sense to take a new direction in life and start up a small business. With the right funding and opportunity, you may be able to parlay your experience and leadership into a better opportunity as a small business owner. 

If You Have the Most Incredible Idea Ever

Of course, the history books are written by the victors, so we've all heard the proverbial stories about the entrepreneurs who mortgaged their homes and borrowed from friends and family to start businesses, and now they're multi-millionaires. This doesn't happen often, and most small businesses don't make the big-time. But if you have a unique business that really could take off and you don't have access to capital otherwise, this might be your best option.

A decision to raid your 401(k) shouldn't be taken lightly, but when opportunity knocks, Americans often answer the door. We're an entrepreneurial bunch. If the opportunity is right and you have other means to fund your retirement, this might just be the mechanism to make it happen.

Would you ever use 401(k) funds to start a business?

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Guest's picture

To avoid going into debt is a pretty bad reason to raid your 401(k). If your business fails you can always declare bankruptcy - bankruptcy can't touch most 401(k)'s - you'll still have your retirement savings...roll it over into the business instead, have it fail...and you'll have nothing.

Darwins Money's picture

That's true for people who are comfortable with the thought of declaring bankruptcy. Frankly, the notion of doing so is so foreign to me, I don't even contemplate that as a viable option. But granted, millions of Americans do. So, food for thought - if that's something you'd do, it beats losing all your retirement money.

Guest's picture

There are pros and cons to this strategy. Pro: better if it were a loan to repay within 30 days at no penalty. Con: could be risky and left with nothing.

But good alternative for some people. Something to consider.

Guest's picture

Awesome article, Darwins. As it turns out, I'm doing this right now. I relocated from New York to North Carolina and decided to take this opportunity to jump from moonlighting to full-time freelance writing as part of the move. I took a disbursement from the 401k and we're using that and some savings to fund the start-up and cover living expenses for the months it takes for me to get self-sufficient. It's scary and exhilarating at the same time. Like you said, when opportunity knocks, Americans tend to answer. Here's hoping it was the right choice!

Darwins Money's picture

Hey, there's a go-getter! Come back and let us know how it's working out!

Guest's picture

To be totally honest, I think the 401k v debt comparison is a poor choice: the debt wins hands-down because a decent business can always pay (deductible) debt off over time.

For an entrepreneur, the 401k is her insurance policy against lifetime financial failure ... you don't want to cash out your insurance policies, if you can at all avoid it!

However, I agree with your basic premise, Darwin, because for many people starting a business raising debt or equity capital simply isn't an option: it's just not available.

If you can't raise enough money via debt (your credit cards are maxed out, you're upside down on your home mortgage) or equity (the Four F's - Founders, Friends, Family, Fools - are all tapped out) then I say your 401k's fair game!

Greg McFarlane's picture

This article has more actionable advice than any I've ever seen on Wise Bread. (I wish I'd written it.) I'd recommend starting with a CPA instead of an attorney, though.

And while history books are indeed written by the winners, I have yet to meet the restaurant owner/operator who says, "You know what? This isn't for me. I wish I was still waiting tables at the Olive Garden."