Many business owners face an uphill battle when it comes to financing. The average startup may be too small for venture capital, and partnerships can dilute control of the business. Loans are expensive, and sometimes only cover a small portion of business needs. Savvy entrepreneurs look into all forms of financing, and this should include their own 401(k) plans.
If you want to use 401(k) money as business capital, you have to fulfill several qualifications. First, your business must be a corporation -- it has to issue shares of stock that the 401(k) can buy, and it must provide a valuation for those shares on an annual basis. Second, the 401(k) must allow the purchase. If you set up the plan yourself, you can write this in to the plan document. If you use another employer's 401(k), the stock purchase should fit into the plan's investment policy. Most self-directed 401(k) plans have liberal policies, but verify the rules before you count on making a purchase.
If your business sponsors a 401(k) and allows employees to direct their own investments, the stock must be available to all employees equally, both inside and out of the plan. This may, however, result in some dilution of company control, as each shareholder earns the right to vote on company issues. Shares held within the 401(k) plan itself are somewhat different as the plan owns the shares and the plan trustee is responsible for any voting, not individuals.
As of September 2011, this type of self-investment is legal. The IRS generally restricts the use of tax-preferred funds such as those in a 401(k), however, and it is possible that self-investment may be declared illegal in the future. As it stands, business owners should be very careful to review all investment plans with an attorney and an accountant to avoid any action that might disqualify the 401(k) plan. Disqualification results in immediate taxability of all plan funds, and an additional 10 percent penalty.
Investment is not the only option for business owners who'd like to tap into their retirement funds. Many 401(k) plans offer a loan option, where the participant can borrow from his account and pay the fund back over time. While most plans require interest on plan loans, you are paying your retirement account, not the bank. All loans must be repaid in full immediately upon termination of employment. Another option is an outright distribution -- if you are older than 59 1/2 or take substantially equal payments for at least five years, you can remove money from a 401(k) plan without paying a penalty. The distribution is taxable as income in the year you take it.
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