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Using Retirement Funds to Start a Business

Avoid Penalities with a Business Directed Retirement Account

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You started a retirement account, whether it’s an IRA, 401 (K), etc. for the purpose of building your retirement assets. Over time, your retirement account may have grown to a sizeable nest egg by investing into stocks, bonds, and mutual funds etc.

But the reality with retirement accounts today is you simply do not get enough returns because you are investing in an underperforming economy.  With minimal alternative investing options available what can you do?

The good news is other than losing money in a 401(K) you can invest in starting your own business instead. However, if you decide to pull money out of your retirement accounts to fund your new business venture there are some key things you should be aware of.

First, expect to pay a 10% penalty when pulling money out of your retirement account before the age of 59 ½. Secondly, considering you don’t have a Roth account, you will also have to pay income tax on the money you pull out regardless of your age. Your income tax can range anywhere from 35% all the way up to 40% depending on your tax bracket.

For example, pulling out $100k out of a retirement account to start a business can cost 31% or $31k of that money in penalties and income tax. That’s $31k in money that you lose that could have been put towards your new business.

An alternative funding solution that allows you to avoid these tax and penalties is called a Business Directed Retirement Account (BDRA). A BDRA allows people to invest their retirement funds into a business, directed it towards the business, so that they can grow with their retirement account.

The advantages of a Business Directed Retirement Account include:

  1. No loans, no banks, and no credit are involved; you are basically taking your own money out of your retirement account and investing it into your own business.
  2. The funds can be used to buy a franchise, purchase a business, buy a property, etc.
  3. Profits from the business can be put back into the retirement account so you earn a return on your investment.
  4. You can pay yourself a salary or wage.

How does the BDRA Program work?

The first thing that is required is forming a business entity. The type of entity formed for this program is a C-Corporation which will be owned by the business owner. The next step is setting up a brand new 401(K) customized specifically to meet the needs for this type of transaction. Once this is completed, the C-Corporation then adopts the 401(K). A company must sponsor a 401(K) for it to be in existence.

Next, the retirement account where funds are currently being held; IRA, 401(K), Keogh plan, or any other type of retirement account, are then moved into the new 401(K). This is where a financial planner comes in handy since he is an expert on it and can do this type of transaction quickly. 

Once the funds are in the new 401(K), the new 401(K) invests in the C-Corporation in exchange for shares of stock. So in this transaction the money is now in the C-Corporation and the 401(K) owns the shares of stock.

Just like your existing IRA or 401(K) right now invests into publicly traded stocks; you’re simply doing this into a private stock. The private stock is your own business. As the C-Corporation grows you can do one of two things. You can put money back into your business over and over again or you can invest funds from your business back into your 401(K).

With this business funding program you are the investor and the owner of the business. Being both gives you the power to make decisions that is based on the best interest for you as a business owner or the best interest for you as an investor.

With a business directed retirement account you have the freedom to invest in your own business.  A BDRA offers the best of both worlds; you have the ability to be the investor and owner of your business. Rather than pulling money out of a retirement account for funding and receiving a 10% penalty and paying income tax of 35-40% this funding program is an ideal alternative.

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