How to Use a 401k to Finance a Franchise

Be careful when raiding your 401k.
Be careful when raiding your 401k. (Image: Robert Kirk/Photodisc/Getty Images)

Starting a franchise can be a great way to profit from a tried and true concept. Unfortunately, the fees associated with opening a popular franchise can be quite high. If you have no other way to raise the money you need to get your franchise off the ground, using the money in your 401k can make sense. But it is important to review your options carefully before raiding your 401k. Understanding the tax implications of each option can help you avoid tax penalties and other unpleasant surprises.

Things You'll Need

  • 401k statement
  • 401k loan application

Research the cost of the franchise you plan to buy. You can find the investment cost of the franchise by visiting the company website or speaking to an investment adviser from the company. The cost of a franchise varies widely, with some franchises requiring an initial investment of just a few thousand dollars, and others requiring franchisees to put up tens or even hundreds of thousands of dollars.

Review a copy of your most recent 401k statement, or check your account balance online. Determine how much of your 401k balance you will need to withdraw to finance your new franchise.

Contact your current employer and ask if the company offers a loan provision on its 401k plan. If you can take out a loan on your 401k, you can avoid the 10 percent tax penalty that would otherwise result from a withdrawal before age 59 1/2.

Obtain a 401k loan application from your employer or the custodian of the plan. Some 401k plans make their loan paperwork available on their websites, while others require you to call and request one through the mail. Be sure to review the loan form and conditions carefully. One downside of the loan provision is that many employers require the 401k loan balance to be paid back in full when the employee leaves, so if you plan to leave your job to run the franchise yourself, you might need a way to pay the money back quickly. Other companies are more flexible with the repayment terms of ex-employees, so reading the fine print is critical.

Complete the loan application for the 401k plan, providing your name, address, Social Security number and 401k account number. Indicate whether you want to receive the money via bank transfer or check. Make a copy for your records, then submit the completed loan application to the address listed on the form.

Contact the administrator of your 401k plan directly if your employer does not provide a loan provision. Be sure to check with an account or tax preparer first, since you will be subject to a 10 percent tax penalty on the money you withdraw. That withdrawal amount will also be subject to current income taxes, so be sure you understand the tax implications before you make your move.

Use the proceeds of your 401k loan or withdrawal to provide the startup financing for your franchise operation. You can transfer the money for the franchise directly from your bank account or write a check to the franchise operator.

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