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Using 401k to Start a Business

Just last year, around 4,050 businesses, with 60% of them being franchises, were financed by retirement money. This paved the way for the creation of as many as 60,000 jobs and a whooping $8.3 billion to the national economy.

Using 401k to start a business has become the new way of making money online.

The practice, which started around 2000, is done usually s by rolling retirement funds to finance startups. Around 35% to 40% of franchisees tapped into their retirement funds in order to launch their business. To date, around 10,000 small businesses started by using 401k to start a business.

Using 401k to start a business is risky, yes, but there are instances when it’s an option that actually makes sense, for a number of reasons.

1. Avoid debt

By tapping into your 401k, you won’t have to borrow money at sky high rates, or seeking peer lending—among other dubious sources of capital.

2. Pursue what you really want

For high-ranking employees with management and operations know-how, using 401k to start a business is a great way to start pursuing what you really want. In fact, most franchisees were employees who were laid off from their jobs, and unable to find a position equivalent to their qualifications.

3. You have a brilliant idea

If you have an idea that you’re 100% ready to stand by, and the people around you agree just the same, using 401k to start a business might be a smart thing to do.

The Legal Technicalities of Using 401k to Start a Business

Using 401k to start a businessAlthough there’s no definitive ruling from the IRS about the legality of using 401k fund for business, there have been confirmations by the IRS of its validity.

Using 401k to start a business is otherwise known as a 401k business financing or rollover a business startup (ROBS).

When using 401k business financing, you have to be careful and follow the IRS. If not, you might end up paying heavy penalties and fines. There are certain legal rules to keep in mind.

1. The business that you’re thinking of must be an active operating company, meaning that it is actively engaged in business. It cannot be a passive investment company.

2. The structure of the startup business must be in conformity with a C-Corporation structure. A C-Corporation structure refers to corporations that are taxed separately from the members or owners.

3. The new 401k must keep in mind that an annual report, the Form 5500, must be filed. Also, the assets of the plan must be annually valuated based on fair market values.

4. If the rules and technicalities are quite difficult to comprehend, you might need to seek the help of a retirement-plan administrator or a financial planner. While this will make you shell out a little extra, you will be getting invaluable information that may save you a lot of money in the long run.

Some considerations when using 401k to start a business

While the idea of using your retirement funds to fund a startup sounds enticing and tempting, you should think carefully before making that huge step. Ask yourself constantly, take all the time you need, and don’t rush into making a decision.

1. Don’t kill the nest egg. You don’t want to lose the security of all your retirement funds for your business idea.

2. Research, consult, and ask. Before using 401k to start a business, ask around and study the condition of the industry. Use your time to research, and figure out if this is a decision that’s people close to you think will pay off

3. Follow the law. You don’t want to be slapped by huge penalties and fines, so observe the deadlines, submit all the necessary documents, and have someone who knows the law beside you.

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