More entrepreneurs are turning to their retirement savings for the start-up funds they need to start new businesses, say advisors and facilitators who deal in this market.
A self-directed 401(k) can be used to start any enterprise that qualifies as a business under the IRS code, notes William R. Seagraves, CEO and president of Catchfire Funding in Denver.
“My clients are like myself, they are serial entrepreneurs who want to jump out of the corporate track,” says Seagraves. Catchfire Funding helps arrange the self-directed 401(k) plans for businesses financing.
The trend comes at a time when the U.S. Small Business Administration has cut back on loans, although Seagraves and others say it is too early to tell if the two trends are connected.
The number of SBA-backed loans peaked in 2007 at 110,000, but declined drastically in recent years to about 48,000 in 2009, 60,000 in 2011 and 54,000 last year.
Patrick Kelley, the associate deputy administrator for the SBA Office of Capital Access, says large lending institutions such as Capital One, Bank of America, CIT and PNC Bank, no longer make SBA loans.
With a self-directed 401(k), all of the money in a retirement 401(k) or IRA account can be rolled over to the self-directed fund. The entrepreneur then sets up a C Corporation as the business entity. The downside, advisor Keith Klein warns, is that all of the money can be lost if the business fails. There are also numerous IRS and Department of Labor regulations that have to be complied with, he adds.
Klein, an advisor in Phoenix, works with Allan Small at Accuplan Benefit Services in Phoenix when clients want to set up a self-directed 401(k). Small says he sees a lot of interest in the self-directed funds because it opens up what can be done with the retirement money.
“For those looking for alternative investment exposure, a self-directed fund gives the entrepreneur more options, such as real estate,” he says. Some entrepreneurs use the money to create a company to buy and sell houses. Others have used it for such things as buying a family farm, investing in a woodworking shop in Maine, starting a retail store or buying a franchise.
Whatever enterprise the owner of the plan wants to set up, he or she has the advantage of using tax-deferred funds to get started. There are no penalties associated with rolling the money over to a self-directed fund like there would be with withdrawing funds early.