Startup Business Loans: 401k Rollover Option 

After years of toiling for someone else’s profit, you might want to branch out with your own startup business. And while bootstrapping is certainly an option, even a lean startup needs some capital and has expenses in the first year that may not be covered by initial revenues. That’s why understanding business loans and financing options is important. 

Did you know that you can fund a business startup with what you have in your 401k? While putting your retirement on the line for your new company might seem like a huge risk, it’s actually not as risky as some other forms of business financing. 

We’ve gathered the basic need-to-knows on funding your startup with a 401k rollover so you can decide if this is the right financial path for you. 

What is a 401k rollover startup loan? 

A 401k rollover startup loan isn’t really a loan. In reality, it’s a bit of financial maneuvering that lets you invest in your own company with your 401k funds. 

It’s already starting to sound a bit complex, right? That’s why we recommend working with an accountant or other professional if you decide to take this route; a little misstep could land you in deep tax bill territory, so it’s worth doing it right. 

For the purpose of considering this option, here’s the rundown on how it typically works. 

  • You have to create a corporation that can have a 401k structure, and that company has to be a C corporation — it’s the only business structure that allows for this type of investment. 
  • Next, you set up a 401k plan within the new corporation, and the 401k plan must be structured in such a way that it can hold stock in any asset or business held by the corporation (see why you need some expert help with all this?) 
  • Once you have the foundation in place, you can roll your existing 401k or IRA into this new 401k — all without paying any tax penalties, because you’re not withdrawing the money early. 
  • Now you’re ready to launch your new business or buy a business; that business becomes an asset in which you are investing. 
  • You can choose to invest a portion of the 401k or all of it in this business. 

How much does it cost to fund your startup with a 401k rollover? 

When we start talking about using 401k money to fund things, many people start worrying about a big tax bill. And that’s a relevant concern if you withdraw funds from your retirement plan. In this case, you’re simply using legal business structures to change what you invest your 401k in: instead of mutual funds, for example, you’re investing in your own company. 

That doesn’t mean this type of funding is completely without cost. Since you’ll likely need some professional legal or accounting help, you may need to cover the costs of those services. When compared with the interest associated with traditional loans, that one-time expense can be very minimal. 

What are the benefits of funding your business with a 401k? 

Many startups and small businesses are partially or completely funded by the owner’s own pockets, and using your 401k to do so saves money because you’re investing pretax dollars. That’s not true if you take money out of a savings account to fund your small business. Plus, depending on how far you are from retirement, the money you use to fund your business isn’t money you were expecting or needing to be available in the next few years to cover your own living expenses or needs. 

What are the disadvantages? 

One of the biggest disadvantages is that you are using your retirement funds to start the business, and if your company isn’t as successful as planned, you might not be able to rebuild your retirement savings as quickly as you planned. That being said, there are inherent risks with any type of funding you might seek for a small business. For example, if you take out a loan backed by the Small Business Administration, you have to put in a lot of your own money and provide a personal guarantee, which puts your home and personal accounts at risk should the business default on the loan. 

Seek tip: When considering a 401k rollover to fund your new business, take some time to do some personal finance math. How much do you need for retirement, and how much of that are you going to siphon off for your new endeavor? Do you have a plan for repaying what you take out based on business success — and a plan B in case things don’t work out as planned? The answers to these questions help you understand whether this is the right way to finance your startup. 

Another disadvantage of funding your startup with a 401k rollover is that it’s not an option available for everyone who wants to launch a new company. You need to have enough in a 401k to make it worthwhile, which means this is typically an option for someone who has been working and saving for retirement for sometime — or for people in former executive rolls that come with high-paying 401k perks. 

The bottom line on 401k funding for your startup 

The truth is that your 401k is already being invested in businesses. Usually, in publicly-traded companies as part of stocks and mutual funds. You can continue to invest in those companies, which you have no control over, or put your money where your dreams are and invest in your own startup. 

It’s not without some risk, but it’s surprisingly less risky than putting all your current cash into an endeavor and may be less risky for some entrepreneurs than an SBA loan.