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.
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.
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.
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.
If you have a Roth IRA, all qualified distributions would be tax-free. Roth IRA contributions can be withdrawn at any point without tax or penalty. However, if you withdraw earnings before they are qualified, applicable taxes and penalties will apply.
Unlike an IRA, which permits distributions at any point, 401(k) and other defined-contribution plans have different rules when it comes to distributions. In general, one would need a plan triggering event to withdraw from the plan.
However, if a plan participant can show that they satisfy one of the available hardship distribution rules under the plan documents, such as the ability to show immediate and heavy financial need, they would be able to take a taxable plan distribution, limited to the amount necessary to satisfy that financial need, which would be exempt from the 10% penalty, even without a plan triggering event.
Unfortunately, the provision under the CARES Act that allowed for up to a $100,000 penalty-free distribution ended in 2020 and was not renewed in the latest stimulus package, although it could be potentially revitalized at a later time.
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.
Loans from 401(k) plans have favorable interest rates, starting at prime, which sits at 3.25%. The loan can be used for any purpose, including capital for your business.
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.
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.
Essentially, you create a C corporation, which adopts a 401(k) plan. You fund the plan with current retirement money, which invests in the business in return for stock. The sale of the stock gives you the capital to use for business purposes.
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.