Small Business Financing 101: How to Use Your Retirement Account to Fund Your Small Business Startup

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Katie Fleming

Co-founder and COO of Owner Actions

A person at a computer is on the phone working with a ROBS advisor to set up a rollover as business startup from his 401(k).

Many small business startups rely on loans for their early capital needs. But if the idea of hefty loans and debts to third parties makes you feel uneasy, consider using your retirement account to fund all or part of your new business venture.

There are three ways you can use your retirement accounts to help you with your purchase:

  1. Access the money in your 401(k) with a 401(k) loan.
  2. Access the money in certain retirement accounts by setting up a rollover as business startup (ROBS).
  3. Take a distribution from your retirement savings account.


401(k) loan

What is a 401(k) loan?

Through a 401(k) loan, you may be able to access up to $50,000 or half of your vested balance (whichever is less) to invest in your new business. Your 401(k) provider will facilitate the loan, and the terms of that loan will include regular payments of principal and interest.

As the 401(k) holder, you are the owner of the funds you’re borrowing. Because of that setup, you will repay yourself both the borrowed balance and the interest required for the loan. The interest payments may help you offset the investment gains you might have realized had you not accessed those funds.

An important condition of this loan is that you must remain employed and enrolled in your employer’s retirement plan offering for as long as the loan is outstanding. If you resign or are terminated from your job, you’ll be required to repay this loan within two months of your departure. Because of this condition, many entrepreneurs who use this option do it to fund a side business rather than a venture that requires their full-time involvement.

It’s also important to note that some plan administrators have strict limitations on how loan funds can be used. For instance, administrators may prohibit participants from drawing funds to finance a competing business. Be sure to speak with your plan administrator about use limitations before pursuing this option.


Do other retirement savings plans offer loans, too?

In some instances, you may be able to borrow against a 403(b) or a 457(b) loan, depending on the terms set by your plan administrator. At this time, it’s not possible to take out a loan against your IRA.


How much can I borrow?

You can borrow up to $50,000 or half of your vested balance, whichever is smaller.


What are the terms?

Your plan administrator will set the specific terms of your loan, but there are some common terms. Often, the interest rate on a retirement plan loan is 1% plus the prime rate, and most loans require a repayment term of five years. Additionally, some plan administrators charge fees to issue and administer these loans.


What are the risks?

There are four important risks to consider:

  1. The money you withdraw will no longer be invested, so you may miss out on opportunities for investment returns.
  2. Your inability to repay the loan could result in IRS penalties. If you fail to repay the loan, the IRS will recategorize your loan as a 401(k) withdrawal, which may subject you to income tax liabilities and a 10% early withdrawal penalty (if your age is less than 59 ½).
  3. Your inability to repay the loan will also result in the permanent loss of a portion of your retirement savings.
  4. If you resign or are terminated from your job, you may be required to repay the full balance within two months of your departure.


What about the advantages?

There are many advantages to 401(k) loans over other sources of financing. These include:

  • Low interest rates and the ability to earn interest on your repayments
  • Easy qualifications with no credit check
  • Not being under obligation to a third party for financing
  • The avoidance of taxes and penalties on the 401(k) money you access, provided you repay the loan under its prescribed terms
  • The default on your 401(k) loan won’t be reported to credit bureaus, and it won’t impact your credit score or ability to attain future financing


When do the advantages outweigh the risks?

The advantages may outweigh the risks in the following circumstances:

  • You need a relatively small amount of money to cover your early-stage costs.
  • You will remain employed and enrolled in your retirement plan for the duration of your loan.


Rollover as business startup (ROBS)

What is a ROBS?

ROBS is the second option for accessing your retirement savings account to fund your new business. This option is more complex to set up. However, it offers more flexibility for the entrepreneurs who choose to use it.

In a ROBS arrangement, you will roll your retirement account money from your self-directed account or employer’s sponsored account to a new retirement account you create within your small business. Your small business will use the capital it raises from this transaction to cover its early-stage costs.

There are five steps to making this happen:

1: You must establish your new business as a C corporation entity.

2: You must establish a retirement plan at your new business that can accept rollover 401(k) money or other forms of retirement savings.

3: You must enable your new business to sell stock to the retirement plan you’ve set up.

4: You must roll your retirement funds from your 401(k) or another qualifying account over to the plan you’ve established at your new business.

5: You must purchase the stock that your business issued with your rollover funds.


Here is an example of how this works:

Li has $60,000 of vested money in her employer-sponsored 401(k) account, and she’d like to use it to cover the costs of her graphic design startup, Li Studio.

Li is interested in a ROBS transaction, so she works with a ROBS provider to register her new business as a C corporation and set up a retirement plan. Her ROBS provider walks her through the process of issuing stock that’s available to participants of Li Studio’s retirement plan. Then, Li requests a rollover from her 401(k) account to her new retirement savings account at Li Studio, and she buys 100 percent of the shares her new business offers.

Through this transaction, Li Studio raises $60,000, which it uses to cover business and marketing expenses.


This process can be complicated, especially because it will require you to navigate IRS regulations, legal concerns, and the issuance of stock. Most owners who choose this route work with an attorney or ROBS provider to help them through the process.

Need help finding an attorney? Consider working with Contract Counsel. Check out their website here.

If you’d prefer a ROBS advisor, consider one of these options:

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Pango Financial

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Whether you have an existing business or a new startup, Pango Financials’ full suite of innovative funding solutions can help your business get the jump-start it needs to grow and thrive. Their team can help design a plan that incorporates one or more financing options to give you maximum financial flexibility and affordability. Want to learn more? Click the button below to talk with a Pango Financial representative.


Which retirement accounts qualify for a ROBS arrangement?

An attorney or ROBS provider will help you determine which of your accounts qualify for a ROBS arrangement, but generally, you may use funds that are available in any of the following accounts, provided you are parting ways with your current employer or, if staying, your plan allows in-service rollovers:

  • Roth or traditional 401(k)
  • Traditional IRA
  • Roth or traditional 457(b)
  • Roth or traditional 403(b)
  • Keogh plan
  • Thrift savings plan (TSP)
  • Some employer profit-sharing plans
  • Some traditional pension plans


At this time, you can’t use Roth IRAs to facilitate a ROBS transaction.


How does ROBS differ from a 401(k) loan?

Unlike a 401(k) loan, ROBS requires no repayment of debt. ROBS is not a loan program. Instead, it’s a way to purchase equity in a small business to help it raise capital. Because of this arrangement, there are no obligations to make monthly repayments, pay interest, or meet other terms loans require.

ROBS arrangements also differ from 401(k) loans in the amount of money that can be accessed. In a 401(k) loan, $50,000 is the maximum that participants are allowed to borrow. In a ROBS transaction, $50,000 is the minimum that participants are allowed to roll over.


What are the qualifications?

There are three qualifications for eligibility:

  1. You’ll need at least $50,000 in a qualifying retirement account.
  2. You must establish a C corporation entity that can accept your retirement plan rollover and issue stock to raise capital.
  3. You must commit to being an employee of your C corporation and receive a salary from that organization (although the salary may not be paid from the capital the business raised from your retirement plan rollover funds).


What are the costs?

If you choose to work with a ROBS provider, you may be charged an upfront fee to set up both your C corporation and retirement plan and issue stock certificates. Often, this fee amounts to about $5,000. You may also be charged an ongoing administration fee, which may be as much as $200 a month, to ensure your compliance with retirement plan regulations.


Do 401(k) loans and ROBS arrangements share the same risks?

Both options can result in a loss of retirement funds. However, you could lose a significantly greater amount of money in a ROBS arrangement, which does not limit the amount you can roll over to fund a new business. Because a 401(k) loan allows a maximum of $50,000 to be used for startups and business purchases, borrowers don’t stand to lose more than $50,000 of retirement savings. People who enter a ROBS arrangement can lose the full amount of their rollover—which may be much greater than the $50,000 minimum—if their business fails.


When should I choose a ROBS arrangement over a 401(k) loan?

There are several scenarios in which a ROBS arrangement may be a better option than a 401(k) loan:

You plan to quit your day job. ROBS arrangements can help you navigate one of the key limitations of most 401(k) loans: having to stay employed by your current employer. While people who choose a 401(k) loan will need to repay the portion they borrow shortly after leaving their roles with their employer, people who choose a ROBS arrangement can roll over their 401(k) accounts to their new entity and leave their jobs without any repayment requirements.

When you need more than $50,000. A 401(k) loan cannot exceed $50,000. Participants who need more can choose a ROBS arrangement that allows them to access a greater portion of their retirement savings.

When you’re worried about repayment. A 401(k) loan must be repaid, even if the venture it funds fails, to avoid taxes and penalties. However, money that’s accessed through a ROBS arrangement does not require repayment.

When you want a say in how your retirement money is managed. In a ROBS arrangement, you can choose how your new 401(k) is established and managed. In addition, you aren’t restricted by the terms of your employer’s plan administrator.


Before selecting this approach, you should consider the risks, the challenges you may face in establishing the C corporation, and the costs you’ll need to cover to attain assistance from an attorney or ROBS provider. You should also recognize that you may be at an increased risk for an IRS audit to verify your compliance with ROBS regulations.



Wouldn’t it be easier to take a distribution from my retirement account?

Distributions are a much simpler process with some clear advantages. There are no repayment requirements and no limitations on how you can use the money. However, there are important considerations to keep in mind. The first is your age. If you are age 59 ½ or older and are withdrawing from a pre-tax plan, you’ll be required to pay ordinary income taxes on the distribution. If you’re under the age of 59 ½ and withdrawing from a pre-tax plan, you’ll need to pay income taxes on the distribution, and you may be required to pay a 10% early withdrawal penalty.

A tax advisor may suggest strategies for avoiding this penalty, including repaying the full balance within 60 days of your withdrawal or taking substantially equal periodic payments over a five-year (or longer) period.

The second consideration is risk. By withdrawing from your retirement account, you sacrifice a portion of your account balance and the earnings you may have gained on it. If your venture performs well, you may earn the equivalent (or more) of the interest you’d have missed by holding the funds in your retirement savings account. If it struggles, you could lose the funds you withdraw in their entirety. Because of this, retirement account distributions are highly risky and should be considered carefully before proceeding.


How do I decide which option is right for me?

A fractional CFO can help you determine how each of these options may affect your financial future. This person, who can devote hours each week, month, or quarter, can help you weigh the risks and costs against the possible benefits to find an option that’s suitable for you.

Interested in speaking with a fractional CFO? Take a look at these firms:

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Check this out: For a limited time, you can receive $250 off your first month of service, thanks to a discount the airCFO team has set up for Owner Actions. Some restrictions apply. Contact airCFO to learn more.

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Advisory for Startups and Growth-Stage Businesses

Looking for an affordable, on-demand advisor who can help you navigate the financial aspects of your business? Whether you need help optimizing your cash flow, raising capital, strategizing for growth, setting pricing, assessing costs, or analyzing your path to profitability, Bookkeeper360 can dedicate a CFO specifically for your business. To learn more about this service, click the button below.


Keep in mind that 401(k) financing isn’t your only option for attaining the funding you need to start a business. Learn about SBA loans, term loans, asset-backed financing, portfolio loans, and other options, including angel investors and venture capital, in our article, Your Go-to Guide to Raising Capital for Your Small Business.



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