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Pulling 401(k) Cash to Fund a Franchise

dimeThere has been a lot of talk lately, from Joel Libava’s Franchise King blog to recent MSNBC article, looking at whether 401(k) retirements savings should be used to fund a new franchise.  Many franchisors for obvious reasons like this idea, such as Westshore Pizza & Cheesesteaks who focuses their sales pitch as a great 401(k) investment.Use 401(k) money to buy a franchise?  My legal and financial opinion is almost always a NO!  It is too risky to gamble your needed retirement funds in a franchise.  If you need to tap your 401(k) to buy a franchise, you cannot afford to buy a franchise.  If your entire retirement life is already FULLY funded and you have plenty of cash, then use your excess cash for the franchise opportunity.

Professional investors always take a little cash off the table, and your 401(k) is what you took off the table.   Keep it there, don’t risk it away.  You could easily lose ALL your money in a franchise, but you couldn’t lose all your money in a 401(k) even if you tried.  Additionally, a single unit franchise will almost certainly not make enough money to payout and match a six-figure retirement account in less than a decade.

Tax and Match Advantages – Big DifferenceIs 401(k) a good investment in the first place?  YES!  Since your 401(k) investments are done with pre-tax income, you are saving about 30% more than you would have with after-tax income.  Plus, an employer match will nearly double the money that goies into your 401(k) than if you just invested the income from your final paycheck.  Upon retirement, you can control the 401(k) withdrawals to minize income taxes.  Even if the employer is not matching, the certainty of pre-tax investing is powerful because it is taken out automatically, but once the paycheck hits your bank it is much more likely to be spent rather than invested.

About Ryan Knoll

Attorney and advisor with an interest in franchising. Feel free to email me comments and questions on the "Contact Us" page.

5 comments

  1. Hi Ryan,
    Thank you so much for the shout-out! {And congrats on getting some WSJ ink!}
    Long time no bond. GO CAVS!

    Anyway, I hope your readers noticed the beginning of my article on 401k’s. I was inspired to write it because of an article written by the “new” franchise blogger over at AllBusiness.com. If you care to look under “uplifting commentary,” on MY post, it links back to who originally wrote it. Nuff said.

    The Franchise King
    Joel Libava

  2. Many folks–most notably Bruce Schaeffer of Franchise Valuations–have been noting the tax code violation of this strategy. Now it appears that the IRS is agreeing with what Bruce said 2 years ago.

    Apart from the risks detailed by Ryan, be aware that you may face severe tax penalties and that the IRS is now looking very closely at these transactions. The IRS is referring to them as “ROBS” which should give you some idea of how they will be treating these in the future.

    • Is this the same Paul W. Steinberg who failed to pay the taxes on his franchise operations to the extent of over $33,000 with the result that NY State had to go to the expenses of issuing a series of Tax Warrants against him. Go to: http://appsext8.dos.state.ny.us/stwarrants_public/st_search, enter “Steinberg” for the taxpayer name, leave “City” blank, enter “New York” for the county, “Base word” for the search type, and “All.”

  3. My two cents worth as a guy currently stuck in the matrix (i.e. Corporate America) …
    – I think I saw 40% as the average amount people lost in their 401Ks over the last six months. I trust me with my money a lot more than I do the fund managers of the pathetic funds our company offers.
    – If you want/need to escape Corporate America, or if you get tossed out, and you have a viable business opportunity but lack sufficient cash to start it and sufficiently cash flow, I think using your 401K is viable for the right person.
    – As for the IRS, you definitely need to understand the risk before you walk into this (or any other financing arrangement). The IRS memo is very interesting. The good fund-with401K companies are working hard to shore up the points of interest the IRS has raised. From what I can see there are viable ways to structure the deal so the IRS concern is addressed and so that any future audit will be short.
    – No guts no glory 🙂

    • I agree. No guts no glory. For many people most of their net worth is tied up in their 401k and IRA’s. What’s the other option? Get a small business loan through the SBA with a variable interest rate with everything you own as colladeral? I would rather take some of my 401k money and pay cash for a business and essentially buy myself a job. Depending on the type of business I do agree that multiple units may be required, but that’s the goal of any business owner isn’t it? Build a business to a point where you can turn it over to competent management and retire living off a portion of the earnings or sell it?

      Currently, I’m at the mercy of the stock market which can crash at any time. The system is highly manipulated and corrupt. I lost 40% last time and it took over a year to get back what I lost. It’s time to take a portion of my own savings and bet on myself.

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