Finance Using Your 401(k)

[KristineS]

This article (http://www.entrepreneur.com/money/financing/selffinancing/article21652.html) recommends using your 401(k) to finance your business start up.

I'm not sure how I feel about this. On one hand, spending your retirement savings does ensure you'll work extra hard to make sure you build up new savings. I would guess, however, there are also penalties for clearing out your 401(k) early.

Would you use your 401(k) money to start your business? Do you think this is a good way to get start up funds?

[vangogh]

I didn't read the article, but I'd have to disagree. That kind of defeats the whole point of the 401(k). If you keep taking money out of it odds are it'll be empty when you need it.

[Steve B]

It depends on how confident you are in your business plan and what other options you have to finance it.

If you are that confident, then you should be able to convince a bank to be confident in your plan also. That would make using a bank loan a better option financially (using 401(k) funds costs you a 10% penalty right off the bat). But, if it's a case where a bank won't give you a loan because you have no collateral - then it might be an option. It's just a pretty risky bet!

[KristineS]

The theory seemed to be that emptying your 401(k) would give you an additional reason to work to be successful. Personally it sounds a little suspect to me. Why would you put extra pressure on yourself at a time when you're already dealing with a lot of pressure? It also seems like there would be better sources from which you could get the funds.

[Steve B]

Well, that's just crazy. There's enough pressure already - I don't think adding the pressure of destitution for the rest of your life will make you work EVEN harder.

The most important thing is to have a profitable idea and system in the first place. Of course, you need to work hard and hire good people etc. etc. But, a bad idea - despite the amount of work is still a bad idea.

[vangogh]

That is kind of crazy. It's like saying you should just risk everything you have on every idea you have since it will motivate you more. Jumping off a cliff would give me great motivation to fly, but I'm not about jump off a cliff to see if I can fly.

[KristineS]

Jumping off a cliff would give me great motivation to fly, but I'm not about jump off a cliff to see if I can fly.

A very good example, Vangogh. I think the theory is that a 401(k) might be an available source of money for those who couldn't get it elsewhere. It wouldn't be something I would personally recommend doing, but it might work for some. Although I would imagine the penalties for early withdrawal of your money would be steep.

[Steve B]

You don't have to imagine. The penalty is 10% of the amount you withdraw - on top of paying the normal taxes on it that you had deferred.

[KristineS]

O.k., so that clearly wouldn't be a good idea. You'd lose a bunch of your money before you even started the business. It seems like there would be better ways to finance things.

[BillR]

I think it depends on the risk of the situation.

For sake of argument - if you were a skilled professional who wanted to leave a firm and go solo and needed startup capital it's probably not that risky, especially if they have established relationships, etc.

When you take money out of a 401K you are actually obligated to pay it back with interest. In markets like the one right now you could possibly do BETTER with your investment in your 401K getting 6% interest on your return than on the crappy market out there at the moment.

However, if you were going to do it going into any new venture (especially something retail) I'd say no way.

[dcampbell918]

Wow, that does seem risky, though BillR made a good point saying that if it were a skilled professional who needed startup capital, emptying ones 401k might not be as risky as a hot-headed younger guy who just wanted to try something new.

We actually just posted a story about **Spam removed** or buy a franchise. Seems more common in today's economic environment to take a risk with this money that you've earned.

But there are always the venture capital firms that want to finance new business. Kristine, maybe that would be the best way to go, so then no one is losing out on any money right off the bat, right?

[Steve B]

BillR - you're referring to a loan from your 401(k). My comments about the penalty only applies to taking a distribution. You can take distributions for certain circumstances if you are still employed - and, not have to pay them back.

Not all employers allow loans - but, I think most of them do these days.

[Dan Furman]

I'm always of the opinion that some risk is good. But like Vangogh said, that doesn't mean just jumping at any old idea. But if I felt strongly about the business, sure, why not?

[vangogh]

Bill I can understand your point, but I'd still say it goes against the point of a 401(k). The whole point of the 401(k) is to put aside money that you won't touch until retirement so you know it'll be there.

If you start taking it out to finance one thing it becomes easy to use the money to finance another and you'll probably find there won't be anything in there when retirement comes.

There are plenty of other ways you can finance a business.

[Steve B]

As I said before, if it's such a good business investement you should be able to convince a bank to give you a loan. That will avoid a 10% penalty and leave your retirement plan where it belongs.

[vangogh]

Steve I'm thinking the same thing you are. If the investment is that good there should be plenty of other sources for funding.

[Evan]

Everyone here brushed up on good points. "Borrowing" from ANY type of retirement plan is extremely risky. The actual costs you'll incur to "borrow" from a 401(k) specifically make other avenues more attractive. Especially when you factor in the risk of losing your entire "loan". Money that is earmarked for retirement should stay that way.

dcampbell, Very interesting idea about forming the new business and having the corporation take over your 401(k). But I would think that as an "employer", you'd probably be violating your fiduciary obligation by investing virtually all of the assets in the 401(k) into the business.

[tuitionsource]

Bringing back an old thread.

Here is my experience with 401K's. In 2001 my rollover 401K/Ira lost $40k when the tech bubble burst. It took me 6-7 years to recover that lost money. I lost faith in my money manager because the whole time I lost money she kept making money on my monthly contributions and through other fees. All the while she is taking my money and I'm getting my butt kicked I never get a card or a call.

In 2002 I moved the money to self directed IRA/no load finds. I don't have to pay someone to lose my money, I can do it by myself. Then in 2006 I cashed it all out and put it into rental property. I paid all the penalties and taxes and made it all back in a year. Now my "retirement" funds give me money each month now and in the future. I don't have to wait 20 years to realize a tangible benefit from my retirement money.

No this plan is not perfect. There have been bumps in the road. However, last year my wifes 403B lost $20K. My rentals held their value and paid me money each month.

So, in some cases it may make sense to cash out and finance your business with your 401K.

[KristineS]

You make a good point. A lot of people, me included, are watching the value of their 401K accounts sink like a stone right now. Of course, I have a lot of years before I will retire, so there is time for it to rebuild, but for those who are closer to cashing the account in, moving the money to another venue might not be a bad idea.