Use your 401(k) to start a business

By Jeff Schnepper

It's been a tough past year or so.

The value of your house has been battered. In some cases, it's worth less than the mortgage.

So, forget using home equity to supplement your retirement needs. Don't even think about a reverse mortgage for additional cash flow. Sorry.

Also, your 401(k) nest egg has melted into a "201(k)." You're probably back to where you were 10 years ago. Now, chances are, about half of your retirement funds are gone. So, too, are your dreams of a comfortable early retirement.

Maybe you've lost your job.

So, you may have no income, no job and a house whose value is falling, and your only investment is what's left of your retirement money. And those dollars are invested in a stock market you likely no longer trust.

What can you do?

This may be the time to invest in yourself.

Find something you love to do and find a way to make people pay you to do it. Open a business to give yourself a job, an income and a chance to actually pay off that mortgage.

Yes, I know we're in a recession. But that also means jobs are being cut rather than created. Remember, the yang to the yin of danger is opportunity. This is your chance to reinvent your life. If not now, when?

But opening a business costs money. You need supplies, equipment, inventory and all those things the accountants call working capital.

The No. 1 reason for the failure of new businesses is insufficient funds. You're also going to need money to live on while your business is getting started.

Where do you get it?

Schnepper's solution

First, get yourself a lawyer and an accountant. This is not a do-it-yourself project. Though the structure is relatively simple, the implementation can be complex.

Then set up a corporation. You'll become an employee of the new corporation. The new corporation sets up a 401(k) plan that allows the rollover of existing retirement funds into the new account. This is a self-directed plan -- you run it and make all the investment decisions.

• Talk back: What business would you start?

Under your direction, the 401(k) then buys stock in your new corporation. The corporation uses those dollars as seed money to cover your wages and other working capital needs.

You're not taxed on any of the money that goes to your new corporation. And there's no 10% early-distribution penalty either. The key here is that your new 401(k) is making an investment, not a distribution. But what you've done is convert your retirement account into instant business capital by using the rollover process. And you've done it without a tax hit.

Yes, there are dangers

Don't do this without a lot of research beforehand. Market research is critical to the success of any venture.

Then consider whether you really want to work for yourself and whether you're psychologically structured to do so.

It's going to have a major impact on your family as well. Make sure they understand what's going on and truly support you and your venture. Take some classes in entrepreneurship if you need to. Talk to the Small Business Administration.

A study by Case Western Reserve University in Cleveland found that more than half of startups fold within five years. Are you prepared to put what's left of your retirement security at risk?

Continued: Lawyer and accountant are critical

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