With the high risks and complex regulations around using 401k funds for business investments, most people are better off avoiding this route. However, for some entrepreneurs, tapping into 401k funds can provide the capital needed to start or grow a business. This article will examine the pros and cons of using 401k funds for business investments, especially with Fidelity 401k plans.
The main pros of using 401k funds for business investments
The biggest potential benefit is the ability to access a large pool of capital for your business venture. For some entrepreneurs, especially those unable to qualify for business loans, their 401k balance may represent one of the only sources of substantial capital at their disposal. Additionally, 401k loans typically have lower interest rates than other financing options. And unlike taking an early withdrawal, 401k loans allow you to pay back the money over 5 years so that it can continue growing tax-deferred.
The significant cons and risks of tapping 401k funds
First and foremost is the risk of losing your retirement savings if the business fails. Not only would you lose your business investment, but the impact on your 401k could set your retirement plans back years or even decades. You’ll also miss out on any gains that money would have earned if it stayed invested in your 401k. And if you leave your job, the 401k loan likely has to be repaid in full within 60 days or it will be treated as a withdrawal with taxes and penalties. Fidelity and most 401k plans also limit 401k business loans to 50% of your vested balance or $50,000, whichever is less. So for many entrepreneurs, their 401k will not provide enough capital to substantially fund a business venture.
The key 401k business loan rules and process with Fidelity
If you do decide to pursue a 401k business loan from Fidelity, be sure to understand the key rules. The application process is done online, and you’ll need to detail how the funds will be used. The interest rate is prime rate plus 1%, repayable over 1-5 years. To be eligible, you must be employed by the 401k sponsoring employer. Any defaults may trigger immediate taxation and a 10% penalty. The $50,000 limit applies across all retirement accounts, so outstanding loans must be factored in. And you can only have one 401k loan active at a time.
Alternatives to tapping your Fidelity 401k for business capital
Before using 401k funds, explore other options such as business loans/lines from banks or the SBA, credit cards, equity investment from friends/family, crowdfunding, business plan competitions, or personal loans/lines. For many situations, the risks and restrictions of a 401k business loan outweigh the benefits compared to these alternatives. It’s also wise to only use retirement funds you can afford to lose without derailing longer-term goals.
Using Fidelity 401k funds for business carries significant risks but can provide capital to entrepreneurs who qualify and lack better funding options. Carefully weigh the pros and cons as well as alternative financing before tapping into retirement savings earmarked for the future.