Should You Use Your Retirement Funds to Buy a Business?

 This is a common question I receive, especially from people in the U.S. where there are options to use 401(k) savings for financing a business acquisition. While it may seem like a great way to avoid borrowing from a bank or paying high-interest rates, the risks are significant, and it’s essential to understand the implications. https://youtu.be/37t2lK1lZ_w

Using Retirement Funds in the U.S.

In the U.S., there's a legal structure known as Rollovers as Business Startups (ROBS), where you can use your 401(k) savings to invest in a new business. Here's how it works:

1. You set up a new entity to buy the business.

2. Your new entity starts its own 401(k) plan.

3. You transfer your existing 401(k) funds into the new company's plan.

4. As the new company’s controller, you can direct the 401(k) to invest in the business.

While it sounds simple, it's legally complex, and there are companies that specialize in managing this process to ensure you comply with tax laws. However, failure to meet all legal and tax obligations could result in penalties, such as having the transferred retirement funds treated as taxable income.

The Risk to Your Retirement

When clients ask if they should use their 401(k) to buy a business, I ask them a critical question: If the business fails, do you still plan to retire? This money is meant for your retirement, and the failure rate of small businesses is high. Using these funds could jeopardize your financial future, not just your present situation.

The Accountability Problem

Many people are drawn to this idea because they think that by avoiding interest payments to a bank, they’ll save money. However, you should hold yourself to the same standards a bank would when lending money.

If you use retirement funds, you must ensure that the business is producing a rate of return similar to what the bank would expect for such a loan. This means you should be disciplined enough to repay your retirement account with interest, as you would with any other loan. The issue is, most people aren't as strict with themselves as a bank would be.

A Possible Exception: Secured Lending

One scenario where I can see using retirement funds making more sense is if you lend the money from your retirement account as if you were the bank. For example:

• Let’s say you’re buying a small business and need a loan for a vehicle. Instead of borrowing from the bank at an 8% interest rate, your retirement account could lend the money to the small business, secured by that vehicle.

• If the small  business fails, your retirement account, holding a secured lien, can repossess the vehicle and recoup its investment. This way, you treat your retirement fund the same way a bank would, ensuring it’s protected.

• I have no idea how to set this up, you’d have to get tax and legal advice.

Consider Your BATNA

Your decision ultimately depends on your Best Alternative to a Negotiated Agreement (BATNA). If you have other opportunities—like employment or alternative investments—you should weigh those before risking your retirement savings. In cases where you have no other options, using retirement funds might feel necessary, but I caution against it unless you're sure you can protect that investment as a bank would.

Final Thought: Retirement Money Should Be for Retirement

At the end of the day, your retirement funds are meant to ensure a comfortable future. Using them for a small  business acquisition puts that future at risk. Unless you're confident in securing those funds properly, it’s often wiser to leave them untouched and explore other financing options for the small  business.

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