I frequently get asked if funds in an IRA can be used to start a business. Usually the individuals have recently lost their jobs and they are considering starting a businesses they’ve been dreaming about for a while. Often, the only substantial savings these people have to serve as startup capital is tied up in an IRA with their former employer.

The answer to the question is yes, but it’s not as easy as simply withdrawing the funds. Here’s what you need to know if you’re considering using your IRA or to start your business.

In order to use the funds, you would need to roll the existing over into a new IRA under your new business. This new IRA needs to be written in such a way that it’s a holder of stock for the new company, and it needs to be a qualified plan.  

After creating the new IRA and rolling the old one over into it, you would need to use the money in the new IRA to buy stock in the new company. Then you can use that money for startup expenses.

It’s a straightforward process but there are a few caveats:

1) The IRS takes an interest in these types of transactions. They require that compliance issues be met and they carefully evaluate your stock valuation. If the IRS determines that you did not do the valuation properly or made some other error, they can exact steep penalties. For this reason, I advise working with a financial professional with experience in startups and stock valuations.

2) Although using an IRA in this manner is currently perfectly legal, it’s something that the IRS doesn’t favor. Because there are gray areas that aren’t clearly defined, it’s possible that they may issue penalties that were unexpected.

3) There are safer funding options, if you have them. These include using a home equity line of credit, getting a loan from a family member. You could also withdraw the funds from a Roth IRA, as long as the account is at least 5 years old .  You could also withdraw it early from a traditional IRA or 401(k) and suffer the penalties and taxes (which make this option almost self-defeating).