Borrowing From Your Retirement to Start a Business

by Rodney Brooks

Many Baby Boomers are finding that they are not ready for retirement, but they are also not ready to ride off into the sunset. So, they are choosing to be entrepreneurs in their encore careers.

Some have lost their jobs because they were laid off or bought out after spending years with their companies.  Others have simply had enough and quit. Either way, they are ready to do something for themselves.

While some of these new businesses require nothing but a home office, a telephone and a computer, lots of Boomers have dreams of something bigger. You know that bed and breakfast you’ve dreamed of? Or that winery? Or maybe it’s just a little bookstore. But, big dreams require big bucks.

According to the Kaufman Foundation’s 2015 State of Entrepreneurship study, Baby Boomers have been, and will continue to be, an entrepreneurial generation. Some highlights:

  • As they work longer and live longer, Boomers also will be entrepreneurs for longer periods of time.
  • The aging of Baby Boomers will create numerous challenges and entrepreneurial opportunities—and Boomers will be the ones who start companies to capitalize on them.
  • Boomers are the best-positioned people in America to start new companies.

Separately, a January 2015 survey of 2,000 Baby Boomers by the Gallup Organization, both entrepreneurs and non-entrepreneurs, found that Baby Boomers were looking for that “Second Act” or “Encore” career. Their reasons for starting businesses:

  • 32% said it allows them to be independent;
  • 27% said it was to pursue their interests and passions
  • 24% said to increase their income

So, the big question is, where do you get the money to start that new business. And, is borrowing from your retirement savings to do so ever a good idea, especially for something ask risky as a new business venture.

Ken Sutherland, president of LifePlan Group in Raleigh, N.C., has two warnings: Don’t risk your current security, and don’t create a tax problem.

“If you are retired or near retirement, and thinking about starting a business, I ask first, are you starting this for financial desires or personal fulfillment or pleasure?” says Sutherland. “If it is for personal pleasure, I always say don’t risk what you have. “Don’t’ risk your current security for future pleasure.

“If you can borrow in a way that, even if you lose it all, it won’t hurt you, then do it,” he says. “If losing it all would endanger your security, don’t do it.”

Jeffrey Imber, president of Imber Wealth Advisors in Ann Arbor, Mich., says there are two ways budding entrepreneurs can finance their business using their retirement accounts.

One involves transferring your retirement account into a new 401(k) within the new company you are starting. “That money can be used to purchase stock in your new company, which will give you the available capital to start a business. It is a non-taxable event.” he says.

He says Guidant Financial is one company that specializes in this type of arrangement. Guidant, based in Bellevue, Wash., says on its website that it has helped 10,000 small businesses invest more than $3 billion in retirement assets in their small businesses.

“The pro is what you are doing now is you are taking a bit more control of your financial destiny,” Imber says. “You are saying, ‘I have confidence in myself, I will take my retirement money and invest it in my business. I will not let stock market determine my future.’

“But one of the cons is if business fails, you have lost your retirement plan and might have to go back to work.”

The second option is a loan from your 401(k), which he says he does not think is a good idea.

“I do not encourage people to borrow money out of 401(k),” he says. “I don’t like to see that.”

“The advantages of that is that you don’t have to go through credit checks,” he says. “You don’t have to get approved. The money is there, but you do have to pay that back. And you must repay within 5 years. You pay it directly out of your paycheck.”

Imber says 20 percent of eligible Americans have an outstanding loan from their 401(k) with an average balance of $7,600.”

One of the problems with that is if someone retires and has a high loan balance, they will have to pay the taxes on the loan balance.

“Look for other ways to fund whatever you need to,” he says.

Still, there are always exceptions, he says.

“I would discourage it,” he says. “But if that’s the person’s direction is in life, they have their heart set on it, have a business model and have the available cash that they can use as seed money, it might be the best thing they can do in life. It also might be the worst thing. But I am open to that for my client. Especially if someone has other sources of money (for retirement), it’s a calculated risk, but I would support it.”