The views in this article are those of the author and may not reflect the opinions of Quicken Loans and its team members.
The employment landscape has changed dramatically; a growing number of Americans, experiencing substantially less job security than previous generations, are leaning toward the idea of reinventing themselves from employee to entrepreneur. What holds many of them back is this question: Where will they get the funds to buy or start a business? Banks have tighter restrictions on loans than ever, and even if they didn’t, debt is not a great way to start your entrepreneurial venture.
A not yet well-known concept, the self-directed 401(k) – also known as a Rollover as Business Startup (ROBS) – could be the answer for many mid-career entrepreneurs who have accrued a decent amount of retirement dollars in their 401(k), IRA, SEP, SIMPLE, 403b, 457 or other eligible plan. A reasonable target for a self-directed 401(k) for most entrepreneurs is to roll over about 40% of their overall net worth, comprised of home equity, retirement dollars, savings, investments, properties, and all personal assets minus all liabilities.
Some of the benefits of a self-directed 401(k) for funding your new business include:
The Magic of Pre-Tax Investing
When you use a self-directed 401(k) to invest in your business, you are investing your pre-tax dollars. You’re not borrowing it; you’re not withdrawing it. Think of it this way: When you began contributing to the 401(k) you have currently, you were likely investing in your employer’s stock, giving you company shares in return for your cash. It’s the same concept when you invest in the stock of your own small business with a self-directed 401(k).
You can skip the embarrassment of groveling in front of your banker for a loan, and effectively approve yourself.
No Debt, Taxes or Penalties
With no interest to pay and no time schedule to repay for retirement funds, your business benefits from improved cash flow – the lifeblood of any business.
Setting up a self-directed 401(k) plan requires far less paperwork than a loan application, and there’s no business plan required to get your funding.
Get Funding Fast
On average, it takes about three weeks for entrepreneurs to receive their money from the rollover of their current retirement plan and the purchase of their company stock.
You can use the money for salaries, equipment, inventory purchases, or any other legitimate business expense, including a down payment for another loan.
Access to More Capital
Should you need it, a self-directed 401(k) can help you qualify for an SBA loan, and possibly a bank loan, since you’re bringing a substantial amount of your own retirement dollars to your enterprise, making you less of a risk.
Retirement Planning & Tax Deferral
A self-directed 401(k) can help you continue to save for retirement by allowing you to contribute a portion of your entrepreneurial salary back to the plan. The plan also allows for normal employer-matching and profit-sharing contributions. Taxes on all these contributions are deferred until the funds are withdrawn during retirement.
Frozen Yogurt Entrepreneur Learned the Hard Way
When Dave Christianson opened his startup snack shop, Frogurt, in Santa Fe, NM, he unfortunately learned the hard way how debt can cripple a new business. He was originally paying almost $3,000 a month in combined loan payments. As a result, Dave watched a painful percentage of his profits go out the door every month. Then the off-season hit, with its significant drop in tourism in his region. Dave needed a solution, and fast, to stop his cash-flow woes. He logged in to a business forum where he heard about a self-directed 401(k) for the first time, and learned it would allow him to pay off his SBA loan and provide the working capital he needed to stay in business.
“The self-directed 401(k) is a good way to make your money work for you – you’re basically being your own bank, to some extent,” says Dave, who worked with small business financing experts to roll over his 401(k) to his own C-corporation.
“You still have your retirement fund that you can control yourself, rather than someone else controlling that money… I knew there was no way I wanted to keep that money in my 401(k) because I just don’t feel good about the economy,” says Dave, who lost nearly $65,000 in the stock market in 2008.
He had enough faith in himself and his business to know that he would be able to pay back his retirement funds, and do a good job of making that money grow over time. It’s going well, as he and his wife enter their third year of business, and are considering a second location for their frozen yogurt shop.
William R. (Bill) Seagraves, president and founder of CatchFire Funding, of Parker, CO, is the author of the Penguin Random House book, Be Your Best Boss: Reinvent Yourself from Employee to Entrepreneur, released in February 2016. A serial entrepreneur, Bill coaches mid-career Americans on the best route to successful entrepreneurship. Learn more at YourBestBoss.com.
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