by Rick Pendykoski, owner of Self Directed Retirement Plans LLC
‘Starting my own business’ is becoming a consistent answer to the usual questions of ‘what are your future professional plans’ or ‘where do you see yourself in 5/10 years or retirement’. People are getting bolder about taking the entrepreneurial plunge and aren’t afraid of taking the risky route. Though it has become easier to set up a business now, getting the starting capital still remains a tricky spot for many aspiring entrepreneurs.
There are many legal steps to follow while financing your business. Many consider 401(k), IRA or SEP for kick-starting or expanding their businesses. Loans from family and friends come a close second, and then there are those who tap into their retirement reserves. Whatever you choose, use tax-deferred growth in accounts to create wealth to finance the capital fund for your venture.
Get the Timing and Mode Right.
Don’t start digging into the retirement fund at the beginning itself. Consider personal savings to fund yourself at first and leave an emergency fund to cover your living expenses for at least three months, to minimize the ‘no-salary’ blow. Add employee stock options if you have exercised any.
Next, you can consider tapping into the equity of your home, loans from family and friends with fixed interest and payback stipulations. You can also take credit from government and other specialty programs if required. If you still need additional cash after this, then you may consider taking a portion of your retirement income, however keep your withdrawals to a minimum.
How and when you opt for these options will determine the course of your business. Even if you have a brilliant idea and a fool-proof business plan, wrong timing and bad financial decisions will ensure that your business never sees the day of light!
Which Finance Technique to Utilize?
How you use the tax-deferred techniques to fund your start-up business matters a lot. IRAs, 401(k)s and SEPs are all tax-deferred, but they don’t stand on the same ground when it comes to harnessing their wealth-creating potential. Let us look into detail how you can maximize returns from each of them and which one might be best suited for you.
- 401(k)
It is one of the most popular and attractive financing sources opted by many aspiring entrepreneurs for many reasons. Under an employers’ plan, you can borrow up to $50,000 from your account and repay that loan within a stipulated period of time, which is mostly 10 years or less. The interest rate is nominal than most, at just 2-3%. The best part is that the funds you borrow aren’t considered withdrawn and due to this, you won’t be subjected to any taxes or penalties.
However, there is one drawback – since you borrow the money from the employers’ plan, you must exercise this privilege before you quit the job. If this sounds like you might have to borrow the money even before needing it, you are right. You have to figure out a way around this loophole before you take any further step.
- IRAs, SEPs
IRAs and SEPs do not allow you to borrow against them. However, you can access the money kept in each of these accounts by liquidating the mutual funds that you have invested in, getting a checkbook for the account and writing checks for business expenses. It’s important to remember that these withdrawals will be subjected a 10% penalty and taxes. The amount will be added to your current year’s income, and the taxes will be with that year’s return. The good news is that you can minimize these taxes by careful financial planning. Consult with your advisors on how to approach this.
Weigh in the pros and cons of all the options and plough ahead with confidence. Don’t let ambition cloud your judgment. Be wise about the financials, rest will take care of itself. Good luck!
Rick Pendykoski is the owner of Self Directed Retirement Plans LLC, a retirement planning firm based in Goodyear, AZ. He regularly writes for blogs at MoneyForLunch, Biggerpocket, SocialMediaToday, NuWireInvestor & his own blog for Self Directed Retirement Plans.
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