While starting your own business can be an excellent way to secure your financial future, finding the cash you need to get that startup off the ground can be very difficult. One possible solution is to use the funds in your 401(k) plan, but you need to tread cautiously and examine the options before proceeding.
Know Where You Stand
Begin by pulling out a copy of your latest 401(k) statement to see how much you have to work with. You can also check your account balance online for a more up to date figure. Reviewing account balances online is always better, since your most recent statement might not reflect the true balance. The actual balance could be more or less depending on how well or how poorly the stock market has done in the interim.
Once you know how much you have to work with, the next step is to determine how much money you need to start your new business. Once you know how much startup capital is needed, you can better decide where to get the funds you will need. It is tempting to raid your 401(k) for the money, but keep in mind that there are other sources of startup capital available as well. For instance, you could look for a loan through the Small Business Administration, or from your bank.
Of course, you might find that even with these other sources, you still need additional startup capital. In that case it might make sense to turn to your 401(k), but it is always best to minimize the amount of money you need to withdraw. Taking money out of yoru 401(k) might trigger a big tax, as well as a 10% tax penalty. In addition, you lose not only the funds you withdraw but the future return those investments would have earned as well.
The Loan Option
The loan provision of your 401(k) is one thing you should consider very carefully before taking money out of the plan. Consider taking out a loan against the 401(k) balance instead of taking the money out as a lump sum. Using the loan provision on your 401(k) lets you avoid the 10% tax penalty and ordinary income taxes that would otherwise apply.
In addition, when you pay the 401(k) loan back, you are essentially paying yourself back, with interest. The interest rate on this type of loan is generally low, making it easier for you to repay the money you withdraw.
In order to get the ball rolling, you need to first obtain the 401(k) loan paperwork from your employer. When completing the form, be sure to fill it out completely and provide all of the information it asks for. Include the account number from your 401(k) statement, as well as your name, address and Social Security number. Also indicate how you want to receive the proceeds of the loan, i.e. a wire transfer or a check.
Know the Risks
When taking out a loan against your 401(k), it is important to understand the risks as well as the potential benefits. Understand, for instance, that you might be required to pay the loan back in full if you leave your current job with the 401(k) loan balance still outstanding. This is an important consideration if you hope to replace your current occupation with your new business. It is also another good reason to keep the amount you withdraw from your 401(k) to start your business as small as possible.
Doing an Actual Withdrawal
If you do decide that you want to withdraw the money from your 401(k) rather than using the loan provision, it is important to understand the tax ramifications of the decision. If you have other options for startup capital, such as small business grants or loans, it is almost always better to use those options, rather than invading your 401(k) and destroying that important tax shelter. If you take money out of your 401(k) plan early, you will be subject to a 10% tax penalty, as well as ordinary income taxes on the proceeds.
If you do decide that withdrawing money from your 401(k) is the best option, contact the custodian holding your plan. Complete the necessary paperwork to start the withdrawal process. Be sure to include the account number from your 401(k) statement, as well as your name, address and Social Security number. Indicate whether you want to receive the proceeds in a check or via wire transfer.
