The blog post provides an in-depth look at the Paycheck Protection Program (PPP) and how it intersects with business owners’ retirement funds. The PPP plan retirement funds business relationship is explored through various options such as IRA or 401(k) plan distribution, 401(k) loans, and the use of a self-directed IRA or Rollovers as Business Start-ups (ROBS) solution. The post emphasizes that dipping into retirement funds should be a last resort for business funding and encourages consulting with a financial planner before making such decisions. It further highlights the role of PPP in helping businesses stay afloat during the Covid-19 crisis and the potential for a second round of PPP loans for businesses demonstrating a significant reduction in gross revenue.
Introduction to PPP and Retirement Fund Options
The term “PPP” has become a popular three-letter word for millions of business owners across the United States. The government came up with the Paycheck Protection Program (“PPP”) as a way to keep businesses afloat and Americans employed during the Covid-19 crisis. The CARES Act provided over $2 trillion of stimulus to the U.S. economy through many new programs, including the PPP. The PPP essentially provided eligible businesses with a tax-free loan equal to 2.5 times their average monthly payroll cost. So long as the loan was used for acceptable purposes, such as payroll, it would be 100% forgiven.
Overview of PPP Loans
The first round of forgivable loans was disbursed between April and August. According to the U.S. Small Business Administration, which oversees the program, the PPP provided 5.2 million federally guaranteed loans worth over $525 billion.
Unfortunately, the pandemic continues to wreak havoc across the globe, both from a health and an economic perspective. Accordingly, on December 27, a second package, worth $900 billion, was signed into law. It included $600 direct payments to eligible individuals, as well as funding for a second round of PPP loans for small businesses. The new program would only be open to businesses that could show a 25% or greater reduction in gross revenue.
Options for Business Owners with Retirement Funds
The second PPP is expected to be a popular option for many small businesses that have been negatively impacted by Covid-19. For many businesses, the program might not be enough to keep their businesses operational in 2021, though. However, business owners with an individual retirement account (IRA) or a 401(k) plan may have some options to help them and their businesses continue to operate during 2021.
Here are ways a business owner with retirement funds can help fund a business. Note: Taking funds from one’s retirement accounts should be a last resort due to the importance and value of having retirement savings.
Using Retirement Funds for Business Funding
IRA Or 401(k) Plan Distribution
Taking a distribution from an IRA is always an option to get access to cash to help fund your business. A traditional, or pretax, IRA distribution will be treated as taxable income. Further, if you are under the age of 59 ½, you will get hit with a 10% early withdrawal penalty.
401(k) Loan
For business owners with a 401(k) plan that includes a loan provision, one would have the ability to borrow the lesser of $50,000 or 50% of their account value and use the money to fund their business. A loan is generally a better option than a distribution because you are allowed to pay it back to your 401(k) plan with interest. It is important that you pay it back as scheduled, or it will be treated as a taxable distribution.
Self-Directed IRA
The self-directed IRA rules will not allow you to invest your IRA funds into your own business or the business of a disqualified person. However, if you have a sibling, cousin, friend or colleague (nondisqualified person) who needs a loan, you will be able to lend IRA funds or even invest in their business. By utilizing the hard money loan, you can help a friend or colleague get through these difficult times. Moreover, because the loan gets paid back to your IRA with interest, you help diversify your holdings and receive a constant rate of return.
ROBS
The Rollovers as Business Start-ups (ROBS) solution is the only manner in which a person can use their retirement money to invest in a business they, or another disqualified person, will be personally involved in, while not triggering the rules on prohibited transactions. ROBS takes advantage of an exemption under IRC 4975.
Create Your Own PPP
According to Yelp data through the end of August, as a result of Covid-19, “permanent closures have reached 97,966, representing 60% of closed businesses that won’t be reopening.” The PPP and other SBA programs have been helpful, but for some businesses, these resources are just not enough. For those business owners with an IRA or 401(k) plan, there may be other business funding options worth considering.
Bear in mind that using retirement funds for your business should be done as a last resort. Consult with a financial planner to decide if one of these options is right for you.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
Question & Answer
What is the Paycheck Protection Program (PPP) and how does it help business owners?
The Paycheck Protection Program (PPP) was created to provide eligible businesses with a tax-free loan equal to 2.5 times their average monthly payroll cost to help them stay afloat during the Covid-19 crisis. If used for acceptable purposes like payroll, the loan would be 100% forgiven.
What are the options for business owners with retirement funds to fund their businesses?
Business owners with retirement funds can consider options such as IRA or 401(k) plan distribution, 401(k) loans, self-directed IRAs, or Rollovers as Business Start-ups (ROBS) to help fund their businesses.
What is the difference between taking an IRA distribution and a 401(k) loan for business funding?
Taking an IRA distribution will be treated as taxable income and may incur a 10% early withdrawal penalty if you are under 59 ½. On the other hand, a 401(k) loan allows you to borrow a specific amount from your account and pay it back with interest, making it a better option than a distribution.
Can a self-directed IRA be used to invest in one’s own business?
No, self-directed IRA rules do not allow investing in your own business or a disqualified person’s business. However, you can lend IRA funds to a nondisqualified person or invest in their business, diversifying your holdings and receiving a constant rate of return.
What is the Rollovers as Business Start-ups (ROBS) solution for business funding?
The ROBS solution is a way to use retirement money to invest in a business you or another disqualified person will be personally involved in without triggering prohibited transaction rules. It utilizes an exemption under IRC 4975.
