QUESTION: I have almost 30k in my former employer 401k that I would want to rollover all that to solo 401k and then use the entire amount to buy out my partner and therefore own 100% of the business. Our business has 110k a year in contracts and the work could easily be done by one person. So by buying him out I would free up almost half of the income every month to pay myself a larger salary, pay back the funds used from solo 401k, and still have more left over to expand and re invest in the business.
I was wondering if there are any tax penalties for using the funds from solo 401k plan toward this type of investment. I spoke with someone from Edward Jones and they said there was, but I thought differently. I also spoke to someone in my network who said I might be able to rollover my former employer to a 401k and fund a business. Do you know about this and do you recommend I use a solo 401k loan or a 401k to fund my existing business.
Dana W. in Colorado
ANSWER: When considering using former employer 401k funds to finance an existing or new business, if the operational business is currently structured as an S Corp, it would need to first convert to a C Corp; then the C-Corp would adopt the 401k. Subsequently, the C-Corp would then issue new shares to the 401k and then the Corp would use the money to buy out your partner’s shares. Such transaction would not be deemed a distribution since the 401k would be buying stock in the C-Corporation using funds transferred from a former employer 401k to a newly created 401k. However, before proceeding first confirm that your business partner is not a disqualified party (e.g., your son, daughter, father, spouse, etc.)…he might be in which case you will not want to proceed with funding your business with your 401k.
If your business partner is a disqualified party, you may want to open a solo 401k instead and then process a solo 401k loan. When the self-employed business owner borrows from his or her solo 401k, the solo 401k loan rules allow for a loan amount of 50% of the solo 401k balance not to exceed $50,000. The Solo 401k loan is paid back either monthly or quarterly with interest. Visit solo 401k loan to learn the full details surrounding the loan rules.