Do you have a business idea, but do not have the capital to get it started and off the ground? Is this the reason why you are thinking about starting a business with 401k money? This is a very important decision to make, and you need to understand all of the implications first.
I have worked in the investment industry for some time now and have given 401k advice to clients for years.
Although, I am not a tax professional.
Please consult your tax advisor for more information pertaining to your individual case.
With that being said, I would like to take some time and give you the cold hard facts regarding this decision, and the reason why I strongly discourage this practise.
Any distribution that you take from a 401k or IRA account will be taxed at your ordinary income tax rate.
These rates range anywhere from 10% to 35%, depending on how much money you make.
Keep in mind also, if you are under 59 1/2 years old, there is an additional 10% penalty paid to the IRS for taking an early distribution.
Lets do some simple math.
Lets say that you have a 401k account with $50,000 in it, and you are wanting to take a lump sum distribution to fund your new business.
Lets also use a middle of the road income tax rate of 25%.
If you took that distribution, you would owe the IRS $12,000 in additional taxes when you file for the next year.
If you are under 59 1/2 years old, you will owe an additional $5,000 for a total of $17,500.
Now here is where it can get even stickier.
Lets say that you take that $50,000 distribution.
This will most likely bump you up a tax bracket (or 2 or 3), because that distribution will be recorded as income in that particular tax year.
If you are normally in the 25% tax bracket, this distribution will most likely push you into a 28%, 33%, or even 35% bracket.
This new tax bracket will affect all income that you bring into your household for that tax year, including wages from your current job.
Lets say you now fall into a 35% tax bracket and are under 59 1/2, you will now owe the IRS $22,500.
Nearly half of what your 401k is worth.
This does not include the additional taxes you will owe on your current wages, because of the higher tax bracket.
You have to be very careful when you are considering starting a business with 401k money, because as you can see, it can be a very expensive way to raise capital to start your business.
I have another suggestion for you.
One that will not require the need of taking a distribution from your 401k or IRA account.
Why not begin a home based business in online marketing.
The cost to get started is minimal, and the potential for creating a massive amount of income in a relatively short period of time is very high.
I do not have to tell you how large the internet is today, and people are using its power to create wealth for them and their families on a daily basis.
You just need to make sure that you find a good reputable company to stand behind you, and give you the support and training that you are going to need to get off the ground.
There are a lot of scams out there so try to steer clear of these types of companies.
I am here to tell you that this is a very valid option that is real and tangible.