Over the past month, we’ve covered a number of ways you can find money to either start or grow your business ventures, but there is one method that comes up a lot in business conversations: Should personal savings be used to start a business?
The answer is complicated.
Using savings to start your business can be a good option, especially if you don’t need a lot of money to get things up and running. But you’ve worked hard to accrue your savings, and it would be terrible to wipe out that hard work on a business venture that doesn’t make it. So how can you use your savings in a smart way to get things up and running?
How Much Do You Need & What Are Your Current Options
The very first step of determining whether or not to use your savings is figuring out exactly how much money you need and what options are available to you. If you don’t know how much money you need, it’s a quick journey from a solid savings account to no savings at all! Once you have an idea of where you need to start, take the time to consider all of your options. Using your own money comes with the benefit of being in full control of your business, but if you are taking on too much personal risk it might be worthwhile to consider the other funding sources available to you.
Don’t Use All Of Your Savings
Whatever you decide to do, don’t completely drain your savings. This is money that you have saved up for your future and for rainy days – using all of it can put you in a very precarious situation if something goes wrong. When using money from your savings, it’s also best to consider it a loan, and plan on how you’re going to add that money back into your account. Also, give yourself a cap. Some financial advisors say to leave yourself at least $5,000, which is a good rule of thumb, although if you have a lot of money in savings it might be better to keep the number at no more than 50% of your savings.
Consider Borrowing Against Your 401(k)
If you have a decent amount of money in a 401(k) savings account, you can always opt to do a loan from the account. Many 401(k) accounts offer the option of borrowing up to 50% of the account, generally with repayment required within 5 years. Is this your best option for funding your business? Not really. While you can borrow against the account, that money won’t be working for you during the repayment process, and the interest rates on the loan aren’t tax deductible.
There are two other possibilities for using 401(k) funds for your business. You can opt to do an early withdrawal, which will involve paying taxes and fees on the money you take out of the account. If you have over $50,000 in your account, you can also opt to do what is called a Rollover as Business Startups (ROBS). This allows you to add money to a corporate retirement account that can be used to fund a new business venture, but be advised – there are some serious legal hoops that you’ll need to jump through to do this, so it’s absolutely necessary that you work with a pro to get all of the setup done properly from a legal perspective.
Credit Cards Aren’t Always Evil
While it’s generally advisable not to use credit cards to start a business, depending on how much money you need and if you can spread out your startup funds, it might be a better option that taking out money against your savings. If you have bad credit, this may not be a great option for you, as the interest rates may be too high. For those with good credit, you may be able to find cards with low or no interest rates through a promotional introductory period, which may allow you to get the money you need and pay it back in a timely manner. But be certain to pay the money owed in a timely manner, otherwise this option has its own set of fees and penalties that can add up, not to mention ruin your credit.
The Bottom Line: Using savings can be a good way to get your business up and running, if you are smart about it. Don’t put yourself in a position where you can’t deal with emergency costs, and really do your research before opting to mess with your 401(k).