Smart Answers
OCTOBER 13, 2006
Using Retirement Money for a Startup
If you're under 59, you probably don't want to touch your nest egg, but you do have several solid alternatives.
I'm applying for an SBA loan for my new restaurant, and the loan parameters require me to commit to a 30% personal cash injection for this venture. I have a traditional IRA. Can I access that money and use it to satisfy my cash injection?—L.M., Boise
In general, your retirement funds should be used in the way they are intended: To finance your retirement years. New businesses are inherently risky ventures, and most experts would advise you not to risk your golden years on one, especially since you will be losing the IRA benefit of tax-free compounding for your nest egg.
There are probably other ways you can raise the capital you need. Investigate options such as borrowing money from friends and family, taking out a home-equity loan, or selling an asset—and consider your IRA only as a last resort (see BusinessWeek.com, 7/24/06, "A Rumor of Money for Entrepreneurs").
"That being said, only you can decide if betting your retirement dollars on your new business is smart. If you really believe in it, then you may decide that the bet is worth the risk," says Karen Berman, a small-business consultant and author of Financial Intelligence: A Manager's Guide to Knowing What the Numbers Really Mean (Harvard Business School Press, 2006).
HOW OLD? If you decide to go ahead, withdrawing money from your IRA is likely to be costly unless you are age 59.5 or older, in which case you can make IRA withdrawals without paying penalties. (Remember that at the end of the year you will pay ordinary income tax on the money you withdrew.)
If you're under age 59.5, you will likely face both penalties and taxes if you make early withdrawals from a traditional IRA. "Tapping into an IRA for this reason will be a deemed distribution and you will be required to pay taxes on the distribution and any applicable early withdrawal penalties, depending on your age," says Sander Stadtler, a CPA and principal in the San Francisco office of Rothstein Kass.
There are circumstances—such as buying a first home or paying for your education—when it is permissible to take money out of your IRA before you reach age 59.5. You can also take an early withdrawal if you face certain hardships, such as excessive medical expenses or permanent disability. But generally, withdrawing money from your traditional IRA before age 59.5 results in a 10% penalty.
RISKING AN EMPTY ACCOUNT? There is, however, an exception that might work if you are close to age 59. You can take money out of your IRA under a method called SEPP (substantially equal periodic payments), meaning that you withdraw your IRA money on an age-specific schedule, determined by an IRS-calculated life-expectancy table.
The problem is that you must continue withdrawing money from your IRA annually under the SEPP program for at least five years—whether you want the money five years later or not. Worse, if you're under a certain age, you might be required to make withdrawals every year until you reach age 59.5, which could quickly empty your account.
A better strategy might be to avoid a deemed taxable distribution by establishing a pension plan, 401(k), or profit-sharing plan for your new business and then rolling your IRA into one of those investment vehicles, says Anthony Saris, also a CPA and principal at the Rothstein Kass San Francisco office. "If you can do this, then the money you roll in from the IRA could be borrowed tax-free for five years and paid back quarterly," Saris says.
Talk to an accountant about the various possibilities, but whichever option you pursue—proceed with caution.
