Roll it Over

Last updated on May 13th, 2019 at 02:35 pm

Most people who have a 401(k) retirement account are using it to save for retirement. However, some are using their long-term savings accounts for another purpose – as startup capital to launch their own businesses. Cynthia Shicotte, owner of Molly Maid of Lake Country, opened her franchise about two years ago. She and her husband, Dik, leveraged their retirement savings to start the business through BeneTrends Inc., a San Diego-based consulting firm that helps entrepreneurs start businesses with retirement savings.

Shicotte and her husband wanted to own their own business for several years before they made the leap, mainly because they wanted more control over their lives. Without the money in the 401(k) account, they would not have had the startup capital needed to launch the business, Cynthia said.

“We thought it would be a great way to take some of our years of saved retirement funds and put them into an investment into our own company,” she said. “We didn’t take it all. We took about 60 percent of it.”

The idea of converting 401(k) savings for retirement into cash to be invested in starting a new business may sound like a risky financial move to many people, but Cynthia said it made perfect sense to her.

“To me, it feels no different than what we had been doing,” she said. “We were already buying company stock and mutual funds for companies, and it was ultimately the same thing. Here, we were investing in ourselves and our own business, and what could be more safe than that? In the long term, I know the business is going to grow and increase in value and provide solid growth for my husband and me.”

Shicotte’s business has already grown significantly. She started the business with no employees and now has 14 full-time workers, including two managers.

Her revenues have also increased dramatically. She declined to give specific amounts, but she said revenues increased 50 percent last year. She is predicting an increase of about 35 percent over the next 12 months.

“We see things leveling now, as we penetrate the market more,” Shicotte said.

Investing savings that have been earmarked for retirement to start a business isn’t for everyone, Shicotte said, because there is some risk involved.

“It comes back to doing your research and how much you’re willing to take on,” she said. “A 401(k) can be risky too. Just look at the market and how many people have lost value there.”

John Donahue, a shareholder in the employee benefits practice group at Milwaukee-based Godfrey & Kahn S.C., has helped several clients use money from an accumulated 401(k) to purchase a business.

Donahue said he has seen many positive outcomes of the process, but warned that it is a significant risk. Using funds from an established 401(k) plan also comes with costs, complications and limitations, he said.

“It is still a horrendous result when a business fails, and that happens, but if one is an entrepreneur and looking to buy a business, one is willing to take certain risks,” Donahue said.

The most obvious risk is that if the business fails, the client has lost his or her retirement savings, Donahue said.

Converting a 401(k) fund is not the only way to turn retirement savings into a new business.

Donahue also helped one client purchase a travel agency with funds from an individual retirement account (IRA).

An executive with a large company was leaving the firm and wanted to own a travel agency, Donahue said. The price of the business was around $100,000, and the executive could only put $35,000 together on his own but had about $100,000 in a 401(k) from his former employer, Donahue said.

The executive rolled the 401(k) out into an IRA, and from there, he rolled $65,000 into a profit-sharing plan, sponsored by the corporation he established to acquire the assets of a travel agency. In essence, the rollover account acquired stock shares of the new company and established his own retirement fund.

“In effect the $100,000 purchase was funneled through the corporation where $35,000 came from his pocket and $65,000 came from his former employer’s retirement plan, now rolled over to the individual as a new company profit sharing plan,” Donahue said.

That process helped the executive avoid paying any tax penalties for withdrawing funds from his 401(k) plan.

Normally, withdrawals from 401(k) plans before age 59-1/2 are subject to 35 percent in federal taxes and about 7 percent in state taxes.

Other legal and tax ramifications can complicate the process of withdrawing 401(k) dollars for business purposes.

For instance, the executive Donahue helped had to establish the company as a corporation, rather than a limited liability company (LLC) or a limited liability partnership (LLP) to avoid heavy taxes.

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