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    Everything You Need To Know About Using Your 401(k) To Apply For A Loan

    How do you find financing to launch your new business given obtaining unsecured startup loans in this climate is difficult? Investors are especially nervous and if you have no track record, there is no way to erase doubts about your abilities. 

    What can you do? Consider exploring 401(k) business financing.

    401(k) Business Financing Explained

    Statistics report that 80% of entrepreneurs are denied a bank loan. A lender, assuming you find one, is going to require a lot such as collateral and perhaps a cosigner.  Fortunately, there is a better way: 401(k) business financing. 

    Also known as Rollovers for Business Start-up (ROBS), 401(k) financing involves taking money from your retirement account to fund your business. The IRS allows you to do this without incurring a tax penalty or paying early withdrawal fees. There is no borrowing and you are merely using your own money that you previously placed in a retirement account.

    ROBS: What Is It?

    Rollovers for Business Start-ups are perfect when you have no cash on hand to launch a new business. Using your retirement account to fund a new start is authorized by the IRS. To qualify you must have a minimum of $50,000 in your account and be over the age of 59-1/2. The process involves the following:

    1. Create a C-Corporation
    2. Once your corporation is established, set up a retirement plan. A 401(k) is the most common, but there are other ways to fund your retirement, such as profit sharing, defined contribution, and defined benefits plans
    3. Identify a professional to manage investments in the retirement plan
    4. Rollover the funds from your previous retirement account (hence the name “rollover”) into the new retirement plan that has been set up by your C-Corporation
    5. Utilizing the money that has been rolled into your new retirement plan, you purchase stock in the C corporation. Your 401(k) now owns the corporation
    6. Your retirement funds are now ready to be used to cover operating expenses

    Forming A C-Corp

    When you start a business, your accountant will likely suggest forming an S-Corp or LLC, but these structures do not allow you to rollover retirement funds. As mentioned above, once your new retirement account has been established, you are ready to purchase stock in your business via what is known as a QES transaction (Qualified Employer Securities). 

    Other legal structures, such as LLC, S-Corp, LLP, or sole-proprietorship are prohibited from issuing QES. Once your 401(k) becomes the owner of the C-Corp, you can use the cash to rent facilities, hire employees, purchase equipment, and cover operating expenses.

    Build A Retirement Plan

    After launching your business and drawing a salary, you can contribute a percentage to your 401(k). This is the same as being an employee, except in this case you decide your salary and your contribution. Your retirement assets will continue to grow in proportion to your company’s profits. 

    As your salary increases, you can make larger 401(k) contributions to your retirement account. Not only will you replace the money you withdrew, but you have the potential to fund your retirement account at an even higher level due to the success of your business.

    Buy Stock In Your Company

    The C-Corp sponsors a retirement plan that allows participants to purchase employer stock in the private business. As an eligible employee, you are permitted to rollover funds from existing retirement accounts into the new plan. 

    Once the funds from your previous retirement account are in the new retirement plan, the plan takes 100% of the transferred funds and buys stock in the C-Corp. Your 401(k) owns stock in the company while the company now has cash from the sale to launch.

    Benefits Of 401K Business Financing

    • If you want to start a new business or purchase a franchise you need capital. Obtaining an unsecured startup loan is very challenging. If you are fortunate to find a lender willing to finance your startup, they will ask for personal assets as collateral. With ROBS you are using your own money to fund your business
    • With ROBS there is no debt. When you take out a loan, you have monthly payments, plus interest. These payments stress cash flow at a time when you are just beginning
    • As your business prospers, you can make salary contributions to your new 401(k) and continue your retirement savings objectives. As your profits grow, the value of your company’s stock increases, which results in greater returns on the retirement investment

    Conclusion

    Using an existing 401(k) or other retirement accounts to fund your business startup is a smart way to avoid the hassle of loan applications and debt. By following the prescribed procedure for structuring ROBS, you can invest your own retirement funds into your new business, effectively making your 401(k) a shareholder in the new business. Instead of loan payments, you are free to use the cash to operate and grow your new business.