Entrepreneurs often stimulate the economic growth of a nation by turning innovative ideas into reality, forming companies, creating jobs, ensuring pertinent and conducive use of cutting-edge technology, and eventually improving the living standards of the mass. However, aspiring entrepreneurs often face difficulties in arranging funds for starting their dream ventures. In need of financial aid, most entrepreneurs, who don’t have enough personal savings, turn to banks or alternative financers. But, very few know that retirement funds can also be used to start a new business or purchase an existing one. The use of a retirement account as a business funding source often turns out to be the most tax-efficient option.

Those looking to use IRA (Individual Retirement Account) can get a taxable distribution at any time, but those who choose to go for a 401(k) plan, must make sure they have left their jobs, can show financial hardships, or are 59 ½ by age to be able to get access to the plan funds. In the case of a 401(k) plan, fund seekers can end up paying a 10% early withdrawal penalty if they don’t meet the mentioned criteria. Funds from this type of retirement plan can be used for multiple purposes ranging from starting a new business to purchasing an existing one. However, it allows the fund seekers to get access to not more than $50,000 or 50% of their account value and requires the borrowers to repay the loan within a timeline of a maximum of 5 years. The payments need to be made quarterly with an interest rate of around 4.75%. The biggest advantage of using this plan is that entrepreneurs can enjoy tax and penalty-free usage of their 401(k) savings. Also, all interest is paid back to the plan eventually. But, one of the primary disadvantages of this plan is the availability of a limited amount of funds. Hence, before choosing a plan, one must consider his/her age, business plan, and fund requirement.

Using retirement money is one of the most thoughtful business funding solutions and is commonly referred to as Rollover as Business Start-ups (ROBS) funding strategy. ROBS allows entrepreneurs to purchase, start or grow a business. To use the ROBS small business funding strategy, firstly, one needs to form a C corporation that can have multiple shareholders. After that, the business owner needs to get a new retirement plan in the new corporation. Post that, funds from his/her existing retirement accounts are rolled into the newly-created retirement plan. The business owner can then use his rolled-over funds to purchase company stock of the new corporation. Finally, he/she can sell the purchased stock to get funds to start the business. One doesn’t need to pay taxes on the distributions as funds are directly rolled over and not withdrawn from his/her retirement account. Besides, the entrepreneur doesn’t owe penalties for withdrawing funds without meeting the specific age requirement, as the retirement savings are going directly into the business. However, to go with this ROBS plan, one needs to get an informed and dependable advisor, who will provide proper guidance on the paperwork, documentation, and other processes. An advisor also ensures compliance with IRS/DOL regulations. ROBS transactions are for those who can’t qualify for other types of financing, don’t want to take on debts, and are not looking to pay early withdrawal penalties, and a distribution tax.

However, ROB plans come with a few disadvantages. There always remains a risk of losing retirement funds in the case of business failure. Also, one loses out on the retirement saving profits that could have come from a rising stock market. Besides, operating a C corporation is more beneficial for large businesses than small ones. Hence, those looking to start a medium to small-sized business might not find ROB plans viable. The high fees that ROB providers charge, the hefty tax liabilities that come with C corporation, the compulsion of staying in compliance with IRS/DOL regulations, etc. are a few other disadvantages of this kind of business funding option.

Alternatives to ROBS Financing, 401(k) and IRA Plan:

Business Line Of Credit

It is one of the most convenient business financing options for entrepreneurs looking for funds to grow businesses, pay for start-up costs or purchase inventory. Like a business credit card, it offers the borrowers credit limits, from which they can withdraw as much as they require at the moment and save up the rest for future use. The withdrawn amount can be paid back at any time to reset the credit line, which can be again used when needed. The best part about business lines of credit is that interests are applied only on the withdrawn amount and not on the entire approved credit limit. These are provided by both banks and online lenders.

Personal Business Loans

In the case of personal business loans, the creditworthiness of the loan applicants is determined based on their personal credit history, available business assets, etc.

Summary

Every financing option comes with certain advantages and disadvantages. An entrepreneur’s business plan, preferences, loan eligibility, and financial requirements decide the right financing option for his/her business.