Can I finance a business with a 401k?

Recently I have been having more conversations about using my retirement funds to start a business that I will be employed with and earning my salary.  There are organizations that are teaching this strategy to unemployed individuals that have former employers 401k that they want to use to invest in a business.  While investing in a business is not a prohibited transaction, however investing in a business that I’m going to run has always been my understanding to be self dealing and personal use.

Internal revenue code 4975 tells us that we nor our lineal decedents or ascendance should benefit from a transaction that our retirement account engages in.  Investing a business like a Sub shop is ok, but me working there and earning my living from that investment is prohibited.  I don’t believe that we can use our retirement accounts to buy ourselves a job. 

In a recent article that I read on an online business magazine promoting this strategy when addressing the salary issue it states that “Another notable issue is that paying one’s salary out of retirement funds. To mitigate [the risk of people setting their own salary and consequently bleeding the retirement plan], they recommend that people don’t take a salary out of the proceeds of the retirement fund’s investment. Rather, the salary should come out of future operating revenues. Additionally, they recommend that would-be business owners get a third party, such as an accountant, to tell them what someone in their line of work, in their area of the country, pays themselves.”

Just because they are recommending that we take our salary from the profit of the newly formed business rather than the capital that the retirement account put into the business, it still looks like a distribution. If I take the profits from any investment in my retirement account, that is called a distribution and is a taxable event.  There is no difference from me taking the profits of the business my retirement account owns and calling it a salary and taking a distribution of the profits from my retirement account.

I recently spoke with an attorney and asked him to clarify this strategy; his first response was that if it walks like a duck and it quakes like a duck then it’s a duck.  To him it was a prohibited transaction.  Because so many Americans are out of work and have funds in their previous employers 401k, they are desperate to find work even if it means using their retirement accounts to buy them a job.  But I would be very cautious of going down this slippery slope of possible prohibited transactions.  Our retirement accounts are meant for our retirement years not to create job opportunities for us. 

If this a strategy that you are considering I would recommend you find a good attorney and CPA that understands internal  revenue code and has a good understanding of the Employee Retirement Income Security Act of 1974 (ERISA).  This is not a strategy that you want to just jump into without a circle of experts around you.  

Remember you can always invest in a business but be very careful if it is a business that you are going to be running.  Like always do your good due diligence and continue your education on the power of self direction. 

Timothy Schubert

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