Can you use your retirement savings to start a business? That would seem to be a pretty straight-forward kind of question to most people. But it turns out that this is an area of the tax code where there are two different answers for what is essentially the same situation. That answer hinges on what kind of retirement savings you have – IRA versus 401(k) or similar – and whether or not you intend to get paid by the business you want to create.
In general, you can start a business using IRA funds (see LLC in an IRA elsewhere on the site) if certain formalities and limitations are observed. But one of them is that you can’t get paid: your IRA has to be the beneficiary, not the IRA’s owner or family.
If however, the funds are to come out of a 401(k) or similar plan, there are options available, at least for now, that are more liberal than what an IRA owner can do. If you do need to get paid for working in the business, pulling the money from a 401(k), instead of an IRA, may make that possible.
Now, if you are thinking that it’s goofy that there should be such a significant difference, you are not alone. IRAs and 401(k)s exist to serve the same reason and are treated more or less the same by the Service (at least with respect to the money that’s already in there). So it’s a little hard to get your head around the difference in the first place; and it’s plausible to think that over the course of time case law could develop to close this gap.
But at present, using what is referred to as a ROBS (roll over as business start-up), a person could conceivably start a new business, go to work for that business and get paid a regular salary. Again, that would blow up an IRA-owned LLC immediately; but here, if certain formalities are followed, it can be done legally.
Caution is required for either approach, though. These are extremely nuanced tax topics, and it is beyond the scope of a resource like this to get into the particulars. There’s a lot of information about these topics other places on the web. Anyone considering an IRA-owned LLC or a ROBS should familiarize themselves with the basics from several sources. If still interested, they should contact their tax accountant or lawyer for advice and assistance putting one in place. This is not a do-it-yourself project. A single misstep could lead to the entire balance of your retirement account being de-classified as tax deferred. You could face a tax bill for a 100% distribution, and if you are younger than 59 ½ you would most likely face an addition 10% penalty for early withdrawal. The cost of an error is simply too high. Seek professional help on this one.