How To Use Your 401(k) To Start a Business

What To Know Before Borrowing Against Your 401(k)

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Entrepreneurs can withdraw from their 401(k)s to start a business. This can often be a viable alternative or addition to business loans, investors, grants, and other sources of capital.

There are a few ways to use a 401(k) to fund a business, each with pros and cons. Find out if using this method of financing is right for you.

Key Takeaways

  • Entrepreneurs should consider using their 401(k)s to finance short-term investments where a quick return on investment (ROI) is expected.
  • If the business fails, an entrepreneur risks their retirement savings by using their 401(k).
  • Certain 401(k) loans come with no penalties or income taxes.
  • The borrower has complete control over the funds and does not owe debt to a third party.

Why You Might Use Your 401(k) To Start a Business


A 401(k) can be a great source of starter funds because:

  • Its owner has control over the capital source and where the money is going.
  • The money is available quickly.
  • The entrepreneur is not incurring debt from a third-party institution.
  • Certain types of business withdrawals can be made without paying penalties or income taxes.
  • All interest is paid back to the owner.
  • It does not require a credit check, and your credit score will not be affected.
  • Most people qualify.
  • It’s good for short-term investments in which a quick return on investment (ROI) is expected, such as buying a franchise or equipment.


A 401(k) can be a risky source of business starter money because:

  • It is a drain on personal retirement savings and will require careful planning to recoup the funds.
  • You are risking your retirement savings if the business fails.
  • Some loan terms are dependent on employment status.
  • Not all plans allow business financing, and they vary on how the loans should be repaid.

Options When Using 401(k) Loans To Start a Business

To start a business using a 401(k), an owner should consider the different types of withdrawals, including a 401(k) business loan, a Rollover for Business Startups (ROBS), and a 401(k) distribution.

401(k) Business Loans

If a plan permits, a borrower can apply to take out a 401(k) business loan from their retirement account. This loan is for people who plan to stay employed in their current position and want to take out less than $50,000.

How It Works

Borrowers sign a loan agreement with the terms of interest, fees, and other specifications. Typically, a 401(k) loan term is five years—it can be shorter, but not longer. Most loans are repaid through payroll deductions. Borrowers are expected to pay market interest rates; however, this interest is later paid back to the owner.

Penalties and income taxes are not incurred when taking out a 401(k) loan, making it a cheaper option than a typical withdrawal. However, interest repayments are double taxed: They are paid with after-tax dollars, then taxed again when the borrower withdraws them for retirement.


If you lose or leave your job, you will be expected to pay back the loan within a short period of time, such as 60 or 90 days.

Eligibility Requirements

An employer’s 401(k) plan may or may not offer loans. If it does, most people qualify since the money is coming directly out of the borrower’s funds.

Some plans require borrowers to get consent from their spouses or domestic partners to take out a loan. This is because a spouse may be entitled to a portion of the 401(k) in case of a divorce, and their share may be affected by the loan.

How Much Can You Borrow?

If a plan permits a 401(k) loan, the IRS lets you borrow 50% of your vested total account balance. This amount is capped completely at $50,000. If you have $40,000 in your account, for example, you can borrow a maximum of $20,000. But if you have $1 million in your account, you still can’t borrow more than $50,000.

Pros and Cons of 401(k) Business Loans

Consider the following advantages and risks when deciding if a 401(k) business loan is right for you.

  • Borrowers don't have to pay taxes and penalties if they pay back the loan

  • Interest paid goes back into the retirement account

  • Credit score is not affected by payment default

  • Easy eligibility

  • Dependent on consistent employment

  • Drains a tax-advantaged retirement account

  • Borrowers younger than 59 ½ will owe back taxes and a 10% penalty if they default

  • Most plans charge fees, often a one-time loan origination fee of $50 or $75

  • Double-taxation occurs: Loan interest is paid with after-tax dollars, which will be taxed again when you retire

What Happens If You Can’t Pay Back a 401(k) Business Loan?

If a borrower defaults on their loan, it is treated as a withdrawal subject to back income taxes. Borrowers younger than 59 ½ will also have to pay a 10% penalty fee. This could seriously deplete a business owner’s retirement account.

ROBS To Start a Small Business

A ROBS plan is a withdrawal from a 401(k) that is transferred into a business’s new retirement account. This withdrawal should be more than $50,000, and it is not subject to penalties or income taxes. Many entrepreneurs consider this option as an alternative to going into debt through traditional business loans. A ROBS requires more convoluted steps than a 401(k) loan.

How It Works

A business owner must use the cash infusion in their new business retirement account to buy stock in their company. This builds up starting capital to fund the business without the hassle of loans, debt, or tax penalties. However, that business owner must also go through a rigorous eligibility process.


The IRS warns that while promoters aggressively market ROBS to new business owners, the application process can be complex, and the practice itself is “questionable.”

Eligibility Requirements

To consider starting a ROBS plan, a business owner must meet the following qualifications:

  • Employer plans must allow the rollover of funds from the 401(k). Many plans do not allow this while the borrower is still employed by that company, but funds from previous employers may qualify.
  • A ROBS applicant usually must have $50,000 or more in a pre-tax, rollable retirement account to qualify.

To apply for a ROBS, a business owner must:

  1. Form a C corporation. 
  2. Open a 401(k) plan for your new business. This can also be a profit-sharing plan depending on the business’s needs.
  3. Roll over funds from your old retirement plan to the new one with the plan administrator.
  4. Buy stock in the company using the new retirement plan.
  5. Follow all plan rules. These include allowing employees to invest at the same level as the business owner and following guidelines on business property use. The business owner must be a bona fide employee of their company, and employees must have access to the company’s 401(k) plan.

How Much Can You Invest?

Generally, ROBS plans require that business owners should invest no less than $50,000.

Pros and Cons of ROBS

ROBS should be carefully analyzed from all angles. Here are some important considerations.

  • No debt, interest, penalties, or taxes

  • No credit check required

  • No penalties for default, as a ROBS is not a loan

  • Allows business owners to use their pre-tax retirement money to fund down payments for business loans

  • Complicated eligibility process, including becoming a C corporation, which has major business implications

  • Depleting retirement funds is considered risky

  • Considered “questionable” by the IRS since they only benefit the business owner, and IRS audits on ROBS businesses tend to be burdensome due to heavy paperwork

  • Historically used for businesses on the brink of failure—and when they fail, owners tend to lose their retirement funds and businesses, according to the IRS

  • Costly to start; a set-up fee costs about $5,000, and about $130 a month thereafter, depending on the plan

Distribution From Your Retirement Account

Under certain circumstances, a business owner may withdraw funds directly from their 401(k) for distribution purposes toward their company. They won’t have to pay the money back, but they must meet strict qualifications for the funds to be made available, and the funds are taxed.

How It Works

If eligible for distribution, an employee may opt for their 401(k) plan to distribute benefits in one of three ways. It could be paid out as a lump-sum payment, in multiple payments over a set period of time (for example, five or 10 years), or in an annuity with monthly payments over a lifetime. When you make a distribution of $10 or more, the retirement plan administrator will send you Form 1099-R, which outlines the withdrawal amount in addition to the 20% taxes being withheld.

Borrowers may also face a 10% taxation for withdrawal if they are younger than 59 ½ years old.

Eligibility Requirements

Plans permit distribution when an employee:

  • Reaches age 59 ½
  • Loses employment (by death, disability, retirement, or other cause)
  • Has their plan terminated, and there is no distribution plan defined by the employer
  • Suffers a hardship, putting them in immediate and heavy financial need

How Much Can You Borrow?

Your distribution amount depends on the agreement between you and your employer plan. Usually, if the balance exceeds $5,000, an account owner must give consent before the plan administrator makes a distribution. The plan may also require the consent of your spouse or domestic partner.


If receiving a distribution under a hardship, your borrowing amount will be limited to the amount it takes to pay for the hardship.

Pros and Cons of Distribution From Your Retirement Account

Before taking a 401(k) distribution, weigh the following pros and cons.

  • No loans or debts

  • The business owner has control of the funds

  • Does not affect credit score

  • Tax penalty of 10% for borrowers younger than 59 ½ 

  • Amount is taxable

  • Potential loss of retirement savings

Frequently Asked Questions (FAQs)

How does borrowing against your 401(k) work?

Generally, a borrower must go to their retirement plan administrator to figure out options. Borrowing works differently whether you opt for a 401(k) loan, a ROBS, or a distribution from your retirement account.

What is the penalty for borrowing against your 401(k)?

There are no penalties for taking out a 401(k) loan unless you default on payments. There are no penalties if you opt for a ROBS, but it comes with other hefty costs. If you withdraw funds from your 401(k) for distribution before you turn 59 ½, you will face a penalty of 10%.

Does borrowing against your 401(k) affect your credit?

No. Borrowing against your 401(k) has no effect on credit.

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  1. Internal Revenue Service. "401(k) Resource Guide - Plan Participants - General Distribution Rules." See "Loans from 401(k) Plans."

  2. FINRA. "401(k) Loans, Hardship Withdrawals, and Other Important Considerations."

  3. Crestmont Capital. "Financing Your Business With Your 401(k)."

  4. Internal Revenue Service. "Retirement Plans FAQs Regarding Loans." See "4. Under What Circumstances Can a Loan Be Taken From a Qualified Plan?"

  5. American Society of Pension Professionals and Actuaries. "401(k) Loans: Considerations for a Plan."

  6. Internal Revenue Service. "Rollovers as Business Start-Ups Compliance Project."

  7. Guidant Financial. "The Pros and Cons of ROBS (Rollovers for Business Startups)."

  8. Internal Revenue Service. "Rollovers as Business Start-Ups Compliance Project." See "New Business Failings."

  9. CatchFire Funding. "With Multiple ROBS Providers, How Do You Choose?" See table.

  10. FranFund. "Simple Pricing. No Surprises."

  11. Internal Revenue Service. "When Can a Retirement Plan Distribute Benefits?" See "401(k), Profit-Sharing, and Stock Bonus Plans."

  12. Internal Revenue Service. "Retirement Topics - Exceptions to Tax on Early Distributions." See table.

  13. Internal Revenue Service. "401(k) Resource Guide - Plan Participants - General Distribution Rules."

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