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Retirement savings: how to use them to fund your small business

A growing number of entrepreneurs are using money from their 401(k), IRA or other retirement savings accounts to finance a new or existing business without paying taxes or penalties. The strategy has several key advantages. 

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Tsering Topgyal/AP/File
An Indian counts dollar bills at a foreign exchange shop in New Delhi. Pulling from retirement savings is becoming a popular option for entrepreneurs financing small business ventures.

As Wall Street investors cheer the initial public offerings of Lending Club and OnDeck Capital and seek to cash in on the alternative lending boom, another small-business financing option is growing in popularity and offering advantages over those emerging financing options.

A growing number of entrepreneurs are using money from their 401(k), IRA or other retirement accounts to finance a new or existing business without paying taxes or penalties. More than 10,000 small-business owners have used this strategy since 2005, according to a 2011 Bureau of National Affairs study. Recent industry reports suggest the figure may have at least doubled since then.

This financing strategy is becoming particularly popular as franchisors educate their prospective franchisees about the option. It’s estimated that up to 40% of franchise startups are funded with retirement funds.

Advantages of using retirement funds

Financing a business with retirement funds offers key advantages over traditional financing and emerging alternative options:

No debt, no interest

Business owners invest retirement funds in their businesses as an equity investment rather than a loan, such that the funds don’t need to be paid back to their retirement accounts. As a result, business owners avoid the debt and interest payments that come with other financing options. For startup businesses, these payments can be burdensome and delay, or even threaten, their success.

Faster access

Unlike a loan from a traditional or alternative lender, there is no credit check or time-consuming underwriting process. Typically, the business owner is able to access funds in 10 to 15 business days. For a time-sensitive business opportunity, quick access to funds can make all the difference.

Independence

By using their own money, business owners can often avoid bringing in additional investors, thereby retaining 100% ownership of the business.

How to finance your business with retirement funds

The IRS refers to this financing strategy as “Rollovers as Business Start-Ups” (ROBS). The required steps include: setting up a C-corporation to own and operate the business, setting up a 401(k) Profit Sharing Plan that is sponsored by the business, rolling the business owner’s existing retirement funds into the 401(k), and investing the business owner’s retirement funds in company stock.

The IRS has consistently stated that small-business owners may legitimately conduct a ROBS transaction. Compliance concerns have centered on the ongoing maintenance of the plan, such as whether business owners are filing required annual reports and communicating the plan to new employees.

With transactions this complex, it is imperative to work with professionals who can guide you through the ongoing compliance requirements. However, small businesses that work through the complexities could see some some real advantages.

Learn more about Mark on NerdWallet’s Ask an Advisor.

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