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Dipping Into Your Retirement Fund to Start a Business

Is your 401(k) plan a good source of capital for your startup?

Q: I am thinking about starting a business, but I need a certain amount of cash on hand to launch my idea. I have a good sum of money in a 401(k) plan with a company I no longer work for, so I was wondering if I should pull the money out of the 401(k) plan to help me finance the startup costs?

A: Absolutely not. Don't do it! Take out a small-business loan, raise money from investors, take out a home-equity loan or (I never thought I'd write these words) even go into business with family and friends before liquidating your 401(k). That way, you might lose your friends, family and business associates, but you'll still have your future.

Actually, this is a really tough question. Pretend you're a banker and are lending yourself money from your 401(k) retirement account. Should you make that loan? The 401(k) account is currently earning a return on the money initially invested in it. It's compounding tax-deferred, giving an effectively higher rate of return, and that tax-deferred effect is permanent. For example, if the 401(k) is earning 7 percent tax-deferred, and you're in the 25 percent tax bracket, that's equivalent to earning 9.33 percent in a taxable account.

You (as a banker) should only invest in your entrepreneurial venture if, as the business owner, you're able to offer a better rate of return on the money. So don't loan yourself money from your 401(k) unless you can repay at 9.33 percent interest. And remember: Right now, your 401(k) is probably invested in fairly conservative places. Investing in an entrepreneur, no matter how well you know him or her, is going to be a lot riskier.

Of course, from the other side, as an entrepreneur you should only borrow money from your 401(k) if that's the cheapest money available. If you have to pay yourself back at a return of 9.33 percent, you may be able to find cheaper money through a home-equity or small-business loan.

Consider the Cash Flow

What if you don't care about rate of return? After all, if you own your own business, you can just live off the business income for the rest of your life. If that's what you're thinking, run the numbers and make sure. When you retire with a 401(k), you'll take out living money each year. Make sure your business can pay you a salary of the same amount. And unless you personally will run the business until you drop dead, make sure the business can still pay you a salary even if you have to hire someone else to run it.

Here's a simplified example: You need the business to throw off enough inflation-adjusted dollars to cover your living expenses plus savings or retirement expenses. Let's say that 20 years from now, you believe you'll need $100,000 after taxes to live on. (Remember: 25 years from now, $100,000 may be peanuts.) If your industry averages a 9 percent margin, that means the business needs to bring in $100,000/.09 = $1,111,111 per year just to cover your salary.

Look at the Downside

Let's be hard-nosed realists: The small-business failure rate is astounding. According to BizMiner.com, which tracks industry statistics, the overall failure rate of businesses started in 2001 is around 37 percent. (It varies by industry, of course.) That's more than one in three. Your 401(k) is your retirement safety net. Do you really want to use it to gamble on one-in-three odds?

The baby boomers begin retiring in 2011. As the biggest generation in history, they'll be turning from net contributors to net drains on the economy. Sounds like an attractive world. If you bet your 401(k) and lose, what will you fall back on? The Social Security gap is huge and growing. Americans increasingly vote for tax breaks, thus cutting social assistance, and medical costs (which you'll have) rise much faster than inflation. If you believe there won't be a social safety net for you, consider carefully. You can't put money back into a 401(k) at will, so you'll have to rebuild your tax-deferred nest egg from the ground up. If you're younger, you can take the risk and still have time to build another nest egg. But if you're 50, you're risking much more.

Certainty Matters

Now it's true that some people have taken huge risks and won. You may decide to throw caution to the wind, charge up all your credit cards, liquidate everything and just go for it. Scott Cook was several hundred thousand dollars in debt at one point during Intuit's life, and now he's worth hundreds of millions. But we only know his name because he succeeded. We never hear about the people who take the risk, lose and go bankrupt.

As you may have figured out, I'm fiscally conservative. I've learned from experience that startups are risky ventures. My retirement money is separate from the rest of my life and will never be touched for high-risk ventures. Your situation may be different, however. You may love risk. You may expect to die young. Or you may have a truly astounding idea that's worth the risk. Though I hope I've given you a few different ways to think about the issue, your smartest move will be to find a financial planner who can help you think through all the implications of your unique decision.

For more information, check out "Sources of Capital."

Stever Robbins is the founder and President of LeadershipDecisionworks Inc., a national training and consulting firm that helps companies develop the leadership and organizational strategies to sustain growth and productivity over time. His web site is http://LeadershipDecisionworks.com.


The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.

Stever Robbins is a venture coach, helping entrepreneurs and early-stage companies develop the attitudes, skills and capabilities needed to succeed. He brings to bear skills as an entrepreneur, teacher and technologist in helping others create successful ventures.

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