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.
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.