The only reason why this isn't a good idea is because the author doesn't appear to quite understand the entire tax implications. This makes me think he hasn't done his due diligence.
The author doesn't seem to realize that he will need to pay income tax on the money that he withdraws, on top of the 10% early withdrawal. This makes the cost of acquiring capital much higher than if he took a loan or an investment. If he has $100k in his 401k, and he withdraws it all in one chunk, he will be left with maybe $45k after 10% penalty and taxes.
The upside is that if he does this properly, ie wait until the next fiscal year, and if he doesn't have any other income income, the taxes he pays might be much less than if he had a regular income.
If all he needs is $40k, if I were him, I would look into alternate methods, like taking out a loan, etc. I've gotten some credit card offers for up to $25k interest fee for about a year (2% transaction fee). If he's this confident he will make money, maybe he should investigate this and if it doesn't take off, he can pay it off with a 401k withdrawal. He would need to figure out at what point he would be making income to pay back this loan, etc.
But straight withdrawing money from the 401k seems like a waste.
This is how many people buy those Dunkin' Donuts or McDonald's franchises.
As for it being a good idea ... do you really think your 401k in mutual funds is going to give you a comfortable retirement? After your hard earned 401k savings are pillaged & plundered by the likes of GS and their HF algo's, Ben Bernanke & friends have printed so much money that your retirement fund will barely buy a new car when you retire and Congress has frittered your Social Security away on endless war ... this doesn't seem like such a bad idea!
Goddamn, I wish I knew about this 3 years ago when I did the exact same thing as the OP. I ended up paying the penalty and everything. Although now, three years later we are profitable[1], have 15 employees and never taken a cent from outside investors. So no regrets here.
[1] I should mention that we're a business, not a startup by PG's definition, and were bringing in revenue from day 1.
Wow, that is an awful article, but good to know about the concept. This is even more direct than the practice of forming a real estate investment trust for he purpose of putting IRA funds into a rental property.
I recently liquidated a small portion of my 401k to help with home-buying costs. The tax penalties were steep, but are required to be deducted up-front. So, I liquidated X, and they sent me a check for roughly 0.7X.
I think you have a good point about the merits of getting a loan and liquidating only if you HAD to; I thought the author's points were interesting though about paying a tax penalty now rather than an equity stake to an investor.
they are required to deduct 20% plus a 10% penalty. It is unlikely, if you have any other income at all, that you will not have to pay more come tax day.
The 10% penalty does not count toward your tax liability, so really they only witheld 20%.
I know if I did this right now, it would be closer to 40% for me. Plus the 10% penalty, so I would only get to use 50% of what I withdrew and stash 20% for tax day.
One thing to factor into the equation is that taxes on 401K money are paid eventually anyway. Taxes will almost certainly be higher in the future, but offset by possibly lower income (the annual draw from the 401K). You get compounding in the 401K on tax-deferred money, but there's no guarantee above 1% annually now. Also Congress can keep raising the minimum 401K withdrawal age, before which the 10% penalty applies.
My income (like a lot of people who do tech startups) is variable between $0-40k/yr (pre-funding, etc.) and $150-300k (high paid consulting, post-acquisition, etc.).
What I do is 401k and SEP IRA (and defer) as much as I can during the high income years (and pull forward expenses), then convert it to Roth IRA during the lean years, to take advantage of differences in marginal rate. The goal being to get it all into a Roth as soon as possible at an overall decent rate.
Roth gets you forever compounding, and tax free dividends and other gains, and no taxes on distribution, which is basically ideal.
Deferring taxes is generally preferrable unless you plan of retiring very soon. Mathematically, the amount you save by deferring taxes now can equal up to nearly 20 years of earnings growth, or more at today's low interest and growth rates.
With currently-taxed contributions you don't have to worry about future taxes...but you start off with a substantially smaller base. You also take the risk that future taxes won't be lower than they are now, or that even if they are higher that retirement withdrawals will not be subject to special taxation regimes.
it boggles my mind that people presume ignorance on the part of the actor (as referenced in the blog that "everybody else is doing it wrong").
its a deliberate play against my current income that i will report and its not actually a strict withdrawal. 40k and 10% early fee were strictly an example. that's not actually what's going on in my case, but its a lot more digestable and the vanilla case and I'd do it even if that was my situation (I'm doing better than that).
i was a financial professional and think about that sort of stuff.
You sounded like you didn't know what you were doing because your description in your blog post was very poor. You mentioned you were doing an early withdrawal, so obviously based on what you wrote, it seemed like you are lacking proper knowledge.
All you mentioned was the 10% early withdrawal fees. You also didn't adequately compare your decision with things like taking loans, credit cards, home equity line of credit, etc. Depending on what you expect your cash flow to be, taking short term loans might be a better solution.
Maybe you might know better, but based on what you wrote, it sounds like you made an ignorant decision.
You might want to check with another financial professional if he told you that withdrawing money from your 401k is not a taxable withdrawal.
There are very limited exceptions to the withdrawal penalty, and they are all hardship-based. Launching a startup is not a hardship.
Alternatively, if you are doing one of those Roll-into-Business 401ks...well, you have a fool for a financial advisor or you are being taken for a ride.
Obviously lots of reasons not to do this with 100% of your retirement, but it's possible you have a relatively overfunded 401k (unlikely) vs. other assets (possible). Or maybe you have rich parents who will cover your retirement, so your 401k is just a tax shelter.
There's actually some crazy stuff you can do with a large enough 401k to use it to fund a business startup -- it's called a "Rollover as Business Startup (ROBS)". Essentially you open a new 401k plan for a new business, roll over your old 401k balance to the new plan, and have the new plan buy stock in the employer (i.e. the new company), financing it. Essentially you can get your ownership of a startup into a 401k, a huge tax savings (and complete tax savings if it is a Roth 401k). This also avoids the early distribution penalty and income tax on the 401k balance.
There are lots of issues setting it up (the IRS hates it, many of the people promoting it are scammers, so basically if there are any paperwork deficiencies in the plan, you're screwed), but it has worked, and is technically legal. It requires $50-100k 401k balance to be generally worthwhile, and is mainly used by small business or franchise people who can't otherwise get financing, but is an option.
I did start with the same as everyone else - then I remembered the HN oath - critique the startup not the entrepreneur.
Summary: it looks pretty good, but you are not explaining yourself front and center - pitch to landlords, get the money quote from down the bottom of the page, and please, this is a long haul business - get someone with deeper pockets behind you - you have traction, you have clients, you have committed your last penny - you hit tick every box. Go to SV, find angels. Get a longer runway. Put this on ANgelList now.
So, in the spirit of HN, a critique :
1. Explain the pitch better on the front page - "Landlords - get tenants to fill in applications online. Quicker, easier, can see status of all applicants instantly, and we conduct bank checks and update you in real time"
I had to dig around to understand that (and I may be wrong of course)
(Whats the competition like - I would guess this is something realtors offer routinely)
2. Front page again - no one rents the Golden Gate bridge. Try something that says rental please - give me subconcious cues to what you are selling. look at http://www.istockphoto.com/stock-illustration-13635470-your-... - ten second search brought up hundreds of possibilites.
3. The learn more page - the images on the right look like misaligned iframes - put think borders around them to indicate they are screenshots - try putting them at 45o angles to make it clearer
4. the online application - break it into manageable chunks - bootstrap does tabs - it was daunting on PC - in my iphone its pretty bad.
4. If there ever was a case for having people sign in with facebook or linkedin - this is it. Half of the info wanted from a tenant is in their profile.
5. and back to the front page <<<
"More applications per vacancy, faster inventory turnover and rapid closings. Rocket Lease has saved me $6,000 this year!">>> - its three scrolls down ! Put in in place of the iphone image. or carousel it. sell yourself on your front page. Please.
Its pretty good - I have no idea of the market in the US, but you seem like you are on a long grind to market acceptance, rather than a viral explosion. So I thin your 40K may be a short runway but good luck - and please explain yourself in the front page. As a landlord I would have walked long before understanding or seeing the money testimonial.
lifeisstillgood -- I really appreciate this. hard to get great feedback, and your list shows that you really clicked through the site. spending your time for someone is a fantastic compliment.
This should be a profitable long haul play - build a brand around your story and the value to landlords, sure, but the bread and butter should come from white labelling to every realtor from here to Nebraska. Really, ask for some advice here on pitching to AngelList. You really do hit all the boxes, but sales to realtors is notorious (at least in UK - highly fragmented and demanding market, but they all want nice regular monthly paychecks from rentals - and you are a value add they could sell)
As an older guy on this page I want to point out how valuable even just a few thousand dollars are when they are put away in your twenties in a tax free account. Money in a retirement account is not the same as money in other accounts because in many cases you can give it to your spouse or your children on much better terms then other investment accounts.
You may have read about Mitt Romney's IRA. It is huge. Obviously that is a guy that goes to great lengths to invest wisely and avoid taxes. When you are rich you will wish you could get more money into that account because of it's preferential tax treatment.
That said, I hope your company does great and you end up so wealthy it doesn't matter. People who are hardworking and ambitious usually end up OK even if there financial planning isn't perfect. Good luck.
What assets are tax disadvantaged when transferring to a spouse?
And if you have enough funds to be in inheritance tax territory for children, after gift and education allowances and trusts and nepotistic employment, well then it's OK to give a little to government or charities instead of spoiling the kids to death.
You are really gambling with your feature because the way I get is I'll use my money this way if I win I will get the biggest cut possible, I do not see other reasons of doing it apart from that is easier. But is it worth it? If you had received some founds you could be safe, lose and try again maybe. But you might also had not the opportunity to rise some founds, which would mean that some people do not believe you can have so much success as you believe. They can be wrong, you can be wrong, but it's usually better to have more views on your idea than only yours because it just works better.
I do understand your position and I share it completely. After working for 5 years at Tomtom, I had an idea. It took me half a year to refine it, hire the right people and basically be ready for some round of funding. Thus I found myself stuck with the usual hassle of producing the right material to convince eventual investors to bet on my company.
I spent precious time and efforts in doing useless stuff like business plans, investor packages, etc. And I was also really skeptic about giving away equities. All in all you seek investors for... what? Counseling? Money? Contacts?
Not being able to give myself a clear answer to this question I decided to become the owner of my future and I fully funded my startup with roughly $300000: beestar.eu (shamelessly self promoting here :)).
I am perfectly conscious that I might lose a lot of money, but I do need to worry about the technology I am trying to ship rather than inheriting the compromise burden that comes with investor's money (not to mention the usual equity's hemorrhage).
If everything fails, this will still be the most exciting adventure of my life.
I can't see why many comments label this as "gambling with one's future." What are his alternatives (if he chose to self-fund)? Saving up cash to use as startup funding is pretty much the same thing - and as ezl stated in his post, retirement money isn't sacred.
Actually, to be more specific, "401k" money isn't more sacred than "cash saved up that is liquid." Using either can affect one's retirement/future.
I wouldn't do this. You're already gambling your future by not earning income, depleting your stored reserves, and potentially missing "standard" career advancement opportunities. Don't you realize that most financial advisors recommend you do not put your company's stock in your 401k as a diversifier?
At the end of the day, ezl made the decision and will live with the consequences, so good luck to him.
What makes me nervous, and I consider to be great big red lights on this idea, is that his description of why he did it is full of emotional language about committing and investing in himself and the thrill of making it "real". These are words and approaches that make feel very cautious about anyone because I'm always unsure how much the decision is based on a cold appraisal of the facts and the risk/reward ratio, vs. rah-rah.
I doubt ezl's blog entry is even a tenth of what he went through in making the decision (at least I hope so), so I won't presume to judge. But as an outsider critiquing this idea, I want to see more cold logic, less adrenaline.
Pretty expensive way to go especially because of the tax hit. As a rule you should be dumping as much money into a retirement account as you can once you have some cushion in the bank... Instant ~30pct return on investment for the classic IRA/401k.
I considered this myself once. The thing is, when you begin a start up you are investing yourself already. If you go for VC, you may get less return if you succeed, but the ability to do it all again if you fail.
Do be aware you may owe regular income tax on the distribution as well as the 10% penalty.
For others looking to tap retirement capital you might research self-directed IRAs and 401ks. I don't have one but considered it for a real estate deal recently.
Not necessarily, if this is a Roth-401(k), then there are certainly penalty free distribution options for your personal contributions. If not, there are legal, but backdoor, ways of "investing" your traditional-401(k) into the newly found startup corporation (a family member did this recently). I think you can also take loans against a 401(k).
Either way, please consult a CPA before taking any action.
Having been a landlord in the past, I can also very easily see the market for your product. I really needed it, in fact, and I think your major issues are going to be getting the onboarding experience just right, and letting the landlord / agency communities know about it. (In fact, it might help landlords do it without agency help, which is nicely disruptive.) Those are nice problems to have.
Awful idea! You claim to be perfectly rational, however, that is not the case. Would it be perfectly rational for me to forgo my 401k to finance your startup? No, it would not. Irrationality and partiality are one in the same. Do not be biased toward your idea because you might fail -- i.e. "eggs in one basket." Right now your retirement money might not seem sacred, but later on in life...
I did this too, but I was 27 at the time and it was only about $5000 I had in there. It paid off as my company has allowed me to save more now. It is a very risky thing to do. But if you are young and it's a good source of capital. I also like the idea of investing in myself, not some faceless institution.
I like it. If you angle it just right you could hit a goldmine with this.
I would split test the single page vs. multiple page application form.
Get those early users in, get feedback, iterate. Push your main selling points. If you can get some users using this service, you can get many. I like the name too.
Had you considered taking a loan out against your 401K? Most of the financial firms managing 401K's offer them. The interest rates are favorable and you don't get hit with all the penalties. I recently faced a similar decision and opted for the 401K loan.
The main determiner of whether this is gutsy or foolish is what age he is. If he still has two or three decades of earning potential in the workforce in the event his company craters, he can recover.
Just something to think about: the years that are most impactful on your retirement are when you are young. Id argue that he'll have a very hard time catching up through traditional means if he is young and things go south.
The power of compound interest. Every time I look at how much I need to save for a decent retirement I wish I'd started five years earlier (which I completely could have afforded).
That's true, the question is how quickly will he be able to return a similar amount to the fund?
Yes, the next three years might be low but it will rise again and the question isn't just when he can start paying back into it, but how quickly can he get it back to it's current level.
I concur with 35636. Compound interest was the old era. The new era is "pay the piper". Returns will no longer be fueled by $trillions in federal borrowing. Instead they'll be greatly pressured downward (perhaps to negative levels) by austerity measures.
The power of compound interest isn't what it used to be. When you walk into your bank and see a sign proudly advertising 3-year CDs at 1%, that's when you know it's time to start taking chances. Even crazy ones.
Back on topic, let's assume that things stay bad for five years before they pick up some. I can get 3% risk free right now in the UK (cash investment) and five years of that is (compounded) 16%.
The question is can he get the fund back to it's current value plus 16% in five years?
Because it's not just about how quickly he can start paying into it again, it's about how quickly he can get it back to it's current value (or it's current value plus 16%), so he's got a comparable amount when the interest rates do pick up.
Even if it doesn't pick up and 3% is the new norm, that still compounds over 20 years to doubling it's current value. Is he going to be able to / be willing to make up that money in some other way during that period?
That's all a bit all over the place but the point is that low rates aren't nothing (particularly not when compounded), and even with low returns rebuilding that fund isn't going to be trivial.
The author doesn't seem to realize that he will need to pay income tax on the money that he withdraws, on top of the 10% early withdrawal. This makes the cost of acquiring capital much higher than if he took a loan or an investment. If he has $100k in his 401k, and he withdraws it all in one chunk, he will be left with maybe $45k after 10% penalty and taxes.
The upside is that if he does this properly, ie wait until the next fiscal year, and if he doesn't have any other income income, the taxes he pays might be much less than if he had a regular income.
If all he needs is $40k, if I were him, I would look into alternate methods, like taking out a loan, etc. I've gotten some credit card offers for up to $25k interest fee for about a year (2% transaction fee). If he's this confident he will make money, maybe he should investigate this and if it doesn't take off, he can pay it off with a 401k withdrawal. He would need to figure out at what point he would be making income to pay back this loan, etc.
But straight withdrawing money from the 401k seems like a waste.