Many people who start or purchase a business take out loans to finance it, but this isn’t the only option. It’s possible to avoid going into debt by using your own retirement funds instead. Although withdrawing these funds before a certain age could result in taxes and penalties, there are ways to access this money without triggering IRS penalties or taxes.
Financing your new business with your retirement funds is possible with two different options: ROBS (rollovers for business start-ups) and self-directed IRAs. We wrote a blog post about funding your business with ROBS versus self-directed IRAs because we want you to get started on the right foot, and this information could help.
How ROBS Works
ROBS is a funding method that allows you to roll over your 401(k) retirement account or other qualified retirement plans into a ROBS 401(k) plan without incurring an early withdrawal or tax penalty. This is not a loan, which means it won’t affect your credit. This makes it an attractive option to people with low credit scores who cannot get loans. Additionally, it’s a good solution for people who are worried about negatively affecting their strong scores.
The downside is that your retirement funds are at risk if the business fails. However, all business investments involve some degree of risk. Many business-owners who cannot repay their business loans end up using their 401(k)s. However, by doing this, they’ll have to pay the early withdrawal penalties and taxes. More importantly, though, the absence of debt and monthly loan payments means you’ll have more funds to spend growing your business.
How Self-Directed IRAs Work
One can also use self-directed IRAs to invest in a business. Large-scale investments can be used to finance businesses, since people can invest more than just money in them. Plus, any earnings from them will result in generous tax breaks for those items.
However, there are some downsides. Self-directed IRAs are much more complex and costly to run, and they’re still prone to taxes and fees if the holder breaks any of the IRS’s guidelines.
The Key Differences Between ROBS and Self-Directed IRAs
Both of these options sound similar on the surface, but there are some key differences to note when funding your business with ROBS versus self-directed IRAs.
With ROBS, you maintain control over the business in which you invest. You can invest funds from your eligible retirement accounts without incurring any taxes or penalties—and you can work for the business. In fact, under ROBS regulations, you have to be an active employee of the business. A ROBS plan even allows you to draw a salary.
If you choose to use a self-directed IRA, you can invest in almost any business as long as you, your spouse, or any lineal descendant of you or your spouse don’t own or control it. In addition, you can’t be involved in running the business, and you can never have more than 50 percent ownership.
If you’re in need of new small-business start-up funding to run your own business and are interested in a ROBS plan, learn more here.