Launching a new business is an exciting undertaking, and bringing your business to life can be incredibly rewarding. However, one element that stops some new business owners in their tracks is finding startup capital. Fortunately, there’s a way to compliantly get startup funding from your retirement account.
If you are starting your own business, you may qualify for a self-directed Solo 401k plan. The Solo 401k plan is also known as a Business Owner’s 401k plan. This type of 401k is specifically for business owners, solopreneurs, and small businesses. There are two qualifications to have your own Solo 401k plan:
- You must have the presence of small business activity
- Your business may not have any full-time W2 employees
You and your spouse are allowed to work for (and be employees of) your own business. It’s also OK for you to have a business partner in your business. You can even qualify for the Solo 401k for your small business if you work a “day job”.
Once you set up and fund your Solo 401k plan, you can tap into startup funding for your business from your retirement account. The procedure to make this happen is called a participant loan and is 100% IRS compliant.
Let’s walk through the steps of funding your Solo 401k and getting the startup funding from your retirement plan. We’ll also discuss another option lurking in the marketplace you should be aware of, as it could cost your retirement.
Funding your Solo 401k
Fund your Solo 401k from rollovers. Almost any retirement account can roll funds into the Solo 401k, including traditional IRAs, and former employer 401k plans. Generally, you can roll funds directly into your Solo 401k. This means you won’t pay any taxes on the transfer of funds into the new retirement account. A competent Solo 401k document provider will provide customized rollover paperwork for you to send to your releasing custodian. This will make getting the rollover check faster and with less hiccups.
The rollover check will come to you directly as your own Solo 401k plan trustee. The check will be made payable to your Solo 401k trust. Deposit the rollover check into a bank account specifically for your Solo 401k trust. This gives you “checkbook control” of your retirement account funds.
Startup Funding from Your Solo 401k
Once your rollover funds are in the Solo 401k, you’re ready to tap into the retirement account to compliantly access your startup funding. The process to access startup funding is called a participant loan. Not all Solo 401k document providers provide for the participant loan provision, so make sure your Solo 401k plan document includes this option.
Taking the loan for startup funding is simple. Your Solo 401k document provider should provide the loan paperwork, including promissory note, amortization schedule, and loan repayment schedule. Once you have your loan paperwork, simply write a check from your Solo 401k trust bank account to yourself as the participant. You may not write the check from the Solo 401k directly to your business as that would be a prohibited transaction.
You can take loan of 50% of your Solo 401k account value, maxing out at $50,000. If your spouse participates in the Solo 401k with you, your spouse is eligible to take the loan as well. This means you can access up to $100,000 in startup funding from your retirement account for your new business.
Why ROBS Could Cost Your Retirement
You may have heard of a structure called Rollover as a Business Startup (ROBS). While some document providers claim the ROBS structure is acceptable, it is a gray area with regard to compliance and the IRS. The ROBS structure has been so problematic, that the IRS created a compliance team just to deal with the issues around ROBS.
ROBS is a compliance gray area because the 401k account is investing directly in the business you own. According to IRS rules, this is a prohibited transaction. Additionally, the ROBS structure is incredibly complicated, has a lot of additional filing requirements and is very expensive to setup and maintain. Keep things simple and compliant. If you need startup funding for your new business from your retirement account, take a participant loan from the Solo 401k!
Comparing options
Getting a small business loan from a bank can be cumbersome and invasive. Not to mention the interest rates can be exorbitant! With a Solo 401k participant loan, there are no approval hoops to jump through because you can instantly approve yourself. Additionally, any interest earned on your loan goes right back into your Solo 401k plan (not to a banker or middleman). Using a Solo 401k participant loan as startup funding for your business also lets you avoid diluting equity in your company by taking on outside investors.
When comparing options, it’s clear the Solo 401k participant loan is a simple, easy, and compliant way to get startup funding from your retirement account. That gives you capital you need to get started so you can focus on the important stuff – launching a successful business!
