How to Use a 401K to Fund a Start-Up Business
Withdrawing money from a 401(k) plan involves numerous restrictions and potential consequences. Still, there are several ways to withdraw 401(k) money to invest in or start a business. The most important consideration is that 401(k) plans allow early withdrawals only for certain reasons. Remember, too, that some withdrawals carry tax consequences, special penalties and suspension from participation in the plan for a period of time.
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Research the plan provisions and rules. You can obtain the plan document and summary plan document from your company's 401(k) website. The website address would be provided to you on your quarterly statement that is mailed to you.
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Determine the withdrawal options for which you are eligible. First is a loan, the maximum allowed is $50,000 or 50 percent of your account balance, whichever is less. This can be used for any reason and carries no tax consequences. If this is enough money, this is always the best solution.
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Look at other in-service withdrawal options. There are typically two other options readily available, a residential home loan and a hardship withdrawal. These funds cannot directly be used to invest in a business. However, if you need a home loan or hardship withdrawal, and have access to another lender, you can use the 401(k) for one of these permitted distributions, and borrow your start-up money from the lender.
To obtain a residential home loan you must be purchasing a primary residence, and to obtain a hardship withdrawal you must have a serious financial need, such as a pending eviction, medical expenses or tuition expenses. The residential loan carries no tax consequences, but the hardship withdrawal entails ordinary income tax, plus a suspension from participating in the plan for six months. -
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Examine other secondary distribution options. If you have rollover funds that you contributed to the plan from another 401(k), you can take that out without restriction. The consequence is that you will owe ordinary income tax. If you are over the normal retirement age of the plan, typically age 65, you may be able to withdraw all of your account while still working. This may be difficult to determine without asking your plan administrator. The plan document will have a phone number you can call.
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Determine if any normal distribution events have or will occur. Leaving the company or becoming disabled would allow for a partial or full distribution. These distributions will carry the ordinary income tax plus a 10 percent penalty if you are younger than 59 and a half. All of these options should be considered carefully as they may have long-term or unintended consequences.
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