Using your retirement savings to start up a business

Are you considering using your retirement savings from a 401(k) Plan or IRA to finance the start of a small business? While the concept may sound like a good idea, there are many complicated tax and legal rules that must be met in order to implement this strategy. The IRS is watching.1 You need to understand the many disadvantages to using this approach.

This is how it’s supposed to work:

  • You’ll need to have a tax deferred account balance in a qualified retirement plan that allows rollovers when you retire or terminate employment.
  • You would then need to set up a C Corporation for your new business. An S Corporation won’t work.
  • The newly established C-Corp would have to set up its own qualified plan (401(k) or profit-sharing plan).
  • You’ll then need to roll your retirement account into the new qualified plan. The plan would then purchase stock in the newly formed C-Corp.
  • This money would then be deposited into the C-Corp’s bank account and be available to use to establish the new business.

Sounds like a good idea, right! But wait . . . not so fast.

The economics of using retirement money to fund a new business is concerning. Many new businesses fail or don’t make a profit which then jeopardizes your retirement savings and income.

Also, what’s the purchase price of the stock of this newly formed Corporation? Since this should be based on fair market value, it would be difficult to assign a value to a newly formed corporation. Overpaying for the stock could be viewed by the IRS as a prohibited transaction.

The IRS may also consider this to be an act of self-dealing, which is also prohibited. If you decide to use your retirement money to start up your new business, you’ll be the sole owner of the stock, CEO/ President of the company, qualified plan trustee and sponsor, participant of the plan, etc. This may be viewed as a prohibited transaction.

Lastly, the plan and the corporate bylaws have to be drafted or amended to allow for the plan to invest in Qualifying Employer Securities (stock). The plan, along with full disclosure of the intended investment, is then submitted to the IRS for an individualized favorable determination letter. It can be a long process and is sure to raise questions with the IRS. Tread carefully along this area of tax law. You don’t want to give the IRS a reason to question the plan.

Although this type of transaction may be technically feasible if properly set up you may want to steer clear. Too many details could go wrong. Betting your retirement savings in a very risky investment should be a concern unless you have significant resources outside of your retirement savings. Additionally, be sure to consult your tax and legal advisors.

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2021-130692 Exp. 12/2023

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Guardian, its subsidiaries, agents, and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation.