Could You Borrow from Your IRA to Start a Business?
Could does not mean should.
When a 5-year-old asks a parent’s permission to do something the parent knows isn’t good for the child, the parent might simply say, “No, you can’t.” If the child asks why, the parent might say, “Because I said so.” End of discussion.
Sometimes parents don’t have the time to give all the reasons.
I felt somewhat like that parent when a caller to my radio show asked whether he should withdraw the money from his IRA or 401(k) account to start a business.
I told him “No,” adding only that the IRS frowns upon it. In hindsight, I feared that I might have given the impression that it’s not allowed.
Besides, I was talking with an educated adult, not a 5-year-old. He deserved a full explanation, so I provided it on the air a week later. Let me share it with you, too.
A section of the tax code features the acronym ROBS — Rollovers as Business Start-ups. It does allow you to take money from a 401(k) without tax consequences provided the money is used to start a business. ROBS is complicated and fraught with problems — so much so that even IRS agents don’t like it.
The process involves hiring an attorney to file an application with the IRS seeking a determination letter in which the IRS gives you permission, provided you follow specific procedures. If you violate any step, the IRS will retroactively assess penalties and taxes. The effort involves forming a corporation structured in a particular way and transferring money from the IRA or 401(k) to the corporation in a precise way. In its own study of the few taxpayers who have gone through this process, the IRS found that most violated one rule or another and ended up with tax problems. Even those who followed the rules didn’t escape unharmed: The majority experienced business failures, with high rates of bankruptcy (business and personal), liens filed against them and corporate dissolutions. Not only did the taxpayers lose their businesses, but their 401(k)s and IRAs were wiped out as well, destroying the erstwhile entrepreneurs’ retirements.
Was I wrong to tell my caller that he couldn’t do it? Perhaps I should have said, “There’s a way you can, but it’s full of risk, your odds of success are slim, you could kill your retirement — so if you want to start a business, find another way to obtain the start-up money.”
You make the call. But either way, please don’t use money in your retirement accounts for anything other than retirement.
Why? Because I’m the advisor and I said so.