The Secret to Turning 401(k) Into Startup Capital

There is a way to dip into your retirement without paying a penalty, but it's not risk-free.
Freelance Writer and editor, Self-employed
July 16, 2012

Most personal finance experts will tell you not to touch your 401(k) until retirement age. The government penalties are stiff and any lost monies just slash the nest egg you’ve spent your professional life building.

“Borrowing or taking out money from your 401(k) is like going to Vegas and hoping to come back with more; it is incredibly risky,” says Denise Winston, founder of Money Start Here, a financial education company in Bakersfield, Calif.

But what if it didn’t have to be this black and white?

Back in 2010, Steve Weinrich found himself laid off and looking for a new opportunity. Sick of working in corporate America, he and his wife planned to buy a Home Helpers franchise, an elderly care company, and relocated to Overland Park, Kan., from New York City.

Without the funds necessary to launch the business, Weinrich called Guidant Financial, a company in Bellevue, Wash., for some help.

“Guidant helped me become the trustee for my 401k plan and then set up a legal company in my name,” he says. “From there, as the trustee, I decided to invest $150,000 of my 401(k) funds into my new company.”

How It Works

David Nilssen, co-founder of Guidant Financial, insists that Weinrich’s transaction is perfectly legal. He started in the company in 2003 to help entrepreneurs “use retirement assets to invest in things in addition to stocks, bonds and mutual funds,” he says. “For us, it makes sense to invest money in assets we can control.” Weinrich can now affect the outcome of his investment because his investment is the company he operates, explains Nilssen.

It’s called a self-directed IRA plan and, according to Nilssen is the “next hot thing” in the startup world. Guidant clients are primarily professionals ranging from 40 to 50 years old who have household incomes of more than $75,000 per year, with good credit, he says.

Guidant helps the client build their own qualified IRA and then rolls existing assets into the new plan, thereby becoming the fiduciary, Nilssen says.

Weigh The Risks

There are risks to this method, but most clients use only a portion of their 401(k) programs, Nilssen says.

“If you think about it, there are always risks when you open a business,” he notes. “Most people use credit cards, SBA loans or bank loans, and any way you do it, you are responsible for the money invested in your business.”

The bonus of using Guidant’s method: your credit and assets aren’t on the line if your business fails, he adds.

Another View

Over in Mobile, Ala., Paula Waldo isn’t a fan of self-directed IRA programs. As a CPA at Zevac & Lindsey, a small-business accounting firm, she warns entrepreneurs against using such methods because, “if you invest your money into a venture and the business bombs, you are out of luck, period,” she says.

In addition to the risk, she says employing a third-party administrator (such as Guidant) can be expensive and is often not worth it, especially if an entrepreneur is looking to invest only a small amount of money.

“I would recommend looking into SBA loans or borrowing against your 401(k) before going this route,” she says. “Going to family members and investors are also good places to start. Simply put, borrowing from your retirement can come back to hurt you if your business doesn’t succeed.”

How do you feel about self-directed IRA plans? Would you ever go this route to start a business? Why or why not?

Photo credit: Thinkstock

Freelance Writer and editor, Self-employed