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Does it make sense to use your 401(k) to start a business?

Think twice before tapping into your 401(k) to

Think twice before tapping into your 401(k) to start a business, experts say. Credit: Getty Images/iStockphoto/DNY59

According to new research from Guidant Financial and LendingClub Corp., baby boomers are snapping up franchises, claiming ownership of 62 percent of all U.S. franchises. What’s eye-catching though, is how boomers are funding their entrepreneurial dreams: Thirty-nine percent use Rollovers for Business Start-ups, also known as ROBS or 401(k) business financing.

But is this the best option?

“It is an absolutely horrendous idea. No one thinks their business will fail, but most do,” says Robert Johnson, CEO of Economic Index Associates in Manhattan.

The idea seems simple enough: Tap your 401(k) to fund your business dreams. But it isn’t.

Tax implications

“The process is difficult," says Joseph Camberato, president of National Business Capital & Services in Bohemia. "To avoid a tax-related consequence, would-be franchisers must incorporate a new business and open a 401(k) plan in it before rolling over the funds. The IRS doesn't view this as ‘illegal,’ but it is considered ‘questionable’ and may raise eyebrows,”  Camberato adds.

Typically, if you withdraw money from your 401(k) early, you’ll pay a tax penalty, often 10 percent, plus income taxes. “You can withdraw money from your 401(k) that is penalty-free, but each plan has its own rules," says Joshua Zimmelman, president of Westwood Tax & Consulting in Rockville Centre. 

"Research your plan to see if this is a feasible option for you,” he says.

Pursue Plan B

Don’t gamble with your retirement safety net, especially when you’re older than 50. Zimmelman recommends exploring other options: angel investors or getting a business loan. Or research whether your company might qualify for a grant if your business has social value or is of other interest to the federal government.

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