When Jody Ordioni needed funds to launch a new advertising and communications business, she didn't hesitate to tap into the 401(k) funds she had amassed over 12 years at her previous job.
"You can't make business decisions based on fear," says Ordioni, 50, president of New York City-based Brandemix, which specializes in brand strategies and earned 2006 revenue of nearly $2 million. "I didn't want to be held back because of money coming to me in 15 years. You can't live on $100,000 in a 401(k) anyway."
Maybe not, but most financial experts advise against borrowing retirement funds to start a business. Launching a new commercial venture poses risks at any age. Add to the equation the fact that many borrowers never repay the money, and you have a financial situation that can be downright terrifying, especially for entrepreneurs who are closer to their golden years than their formative years.
"I frown on borrowing against retirement funds," says Blanche Berenzweig, a certified financial planner and owner of BSB Financial Services in Milwaukee. "It's almost always better to use other sources of income, like some of the equity in your home. If any other resources are available, always tap those first."
You also need to think carefully about digging into those retirement funds because of the hefty penalties and substantial tax bite that accompany early withdrawals. For instance, if you're under the age of 59 and a half, any funds you withdraw permanently from a 401(k) or Roth IRA are subject to a 10 percent penalty. Because deposits were made in pretax dollars, Uncle Sam will be holding out his hand, no matter your age.
But the threat of penalties and fees didn't slow down Ordioni, who used 20 percent of her 401(k) savings to start her company. She replaced the money within a year, and she would not hesitate to use it again if necessary. "In my business, there are a lot of cash flow issues," she says. "That money is a cushion."
If you also need a retirement savings cushion, Berenzweig suggests working with an accountant or tax advisor to minimize the taxes and penalties you'll pay, as well as help you deduct any business losses you might incur, which in turn will decrease your tax burden. It's also usually best to withdraw the money you need in small increments, both to keep the tax hit as low as possible and to preserve your remaining financial assets in case the business doesn't survive. Furthermore, it's crucial to pay the funds back as soon as possible, as Ordioni did.
"Saving [for retirement] isn't always a priority for someone just starting a business, but it has to be," Berenzweig says. "Otherwise, you could severely affect the amount of money you'll have available when you finally do retire."
Of course, if you follow the growing trend among people over age 50 of starting a dream business after retirement, that might be a moot point. "I think of my business as my retirement money," Ordioni says. "Anything I can use to enhance it works for me."
If you're not much of a gambler, consider using more traditional resources for startup funds. Find an angel investor. Look into free government grants (check out the options at www.unclesamsmoney.com, www.grant-sources.com and www.grants.gov). Downsize your home and use the capital gains. Borrow against insurance policies. Advises Berenzweig, "Try anything you can to avoid a negative cash drain."Eileen Figure Sandlin is an award-winning freelance writer and author who writes on business topics.