If you haven’t noticed yet, I’m kind of in love with the Roth IRA.
Having launched the Roth IRA movement, it’s a safe assumption that I think everybody should have a Roth IRA. Heck, if there was a way to open up a Roth IRA for my dog, I would definitely do it.
Several years ago a close friend of mine started investing into a Roth IRA. I was super pumped because any time a young adult starts putting money into a Roth IRA, I don’t see the $50 per month they put into it. I see the potential of hundreds of thousands of dollars they will have tax free at retirement. Getting started earlier on in life is so huge, and it motivates me to be the catalyst behind that.
My friend had been adding money into his Roth IRA for several years and was doing this while launching his brand new photography business. I was really impressed by the fact that he was able to stay in the black from going off on his own and starting a new business while also putting a decent sum into his Roth IRA.
You Wanna Do What?
He continued to do this for several years until the day that he called me. Him knowing how much I loved the Roth IRA, I could tell some hesitance in his voice as he asked me,
“Hey, Jeff. I’m considering cashing out my Roth IRA so that I can take that money and invest it into my business.”
At first I was appalled. What a stupid idea! Did he not realize all the tax-free money he would have at retirement?
My initial response definitely was very unsupportive. I didn’t voice that with him though as I always like to just chew on things a bit to see it really makes sense.
I remember first asking him, “Are you sure you really want to do this?” He responded that he had thought about it a lot, but he had some equipment that he felt if he had it, the return on his investment would be much more than he would realize, especially in the long term, than the Roth IRA.
Now, at the time I was still a W-2 employee, a broker from my previous firm, so I hadn’t quite grasped the business owner concept. At the end of the day I gave my friend the benefit of the doubt basically because I knew he had already made up his mind. My friend began investing early into his Roth IRA, cashed it out, paid some penalties, paid some taxes, and invested the proceeds into his photography business.
Fast forward to present day my friend is known as one of the most premier photographers in our region. He has been able to grow his brand and his business way beyond profitable. He takes several vacations a year, including a one-month vacation in January, which allows him to get a break from his day-to-day operations. In hindsight, him cashing out his Roth IRA paid huge dividends that, although hard to measure, definitely give the impression that has proved to be much more valuable that the Roth IRA could have done.
As you can tell, that experience has made an impression on me because I know that opening a Roth IRA and investing in the stock market is not the only way to go. There are many other ways to make money in investing, and in my experience I have learned not to be so one sided. People can invest in businesses, real estate, partnerships, and many other instruments that will yield them very handsome returns.
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I would have given him the pros and cons and allowed him to make the decision on his own. He obviously really believed in himself and his business and it paid off quite well for him.
I guess it depends on the results. Obviously, it is easy to say in hindsight that he made the right decision. I guess it comes down to weighing the risks and benefits, but you make a great point about the possibilities that are out there when we think outside the box. Great point!
Couldn’t you structure your business so that you could actually own the shares in your Roth IRA? Now you couldn’t access the gains tax free until retirement, but you could save a lot of money if you do make it big!
I’m with Corey, it really depends on the business. If it was a sinking business and the company hadn’t been able to stay in the black then I would advise against it.
While my initial response would have been similar to yours it’s great that it all worked out for the best!
Starting a business can be much more profitable short-term than your tax-free growth in the Roth IRA. But it can also be a waste of money and mean a loss of hundreds of thousands of potential dollars. Either way, it’s a gamble, but at least with the busniess you probably have more knowledge of what you are getting into vs. investing.
Jeff, I am way too conservative. I only take calculated and well measured risks. I would only borrowi from a retirement account in a real emergency. But, as you said, it may work for others.
Totally agree Jeff. My views changed on this when I became a full blown entrepreneur and took some capital out of my own IRA. The net return has been so much more than I would have been able to earn by keeping it in there, but I was also pretty certain that my business would do well. I say invest in yourself first! (and I’m a CFP!) Have you read “Killing Scared Cows”? That guy has some pretty radical ideas about these sorts of things.
Well, the benefits your friend is enjoying is the here and now. Businesses do fail and taking from a nest egg to build one is still not a good idea in my book. You can invest in many things besides stocks and mutual funds with a Roth IRA too. However, I do see your point that you did what the client wanted since he already made up his mind.
If the small business is profitable and established and the Roth IRA money would almost certainly make it more successful and profitable I might be OK with it. However, if you are taking it out to start an untested business you are asking for trouble in my opinion. While it might work out you might lose it all too. It sounds like in this case the business was already successful and adding this equipment would only further his profitability and options going forward.
I’m actually thinking about cashing mine out simply because I don’t have much in it since I’ve been contributing to my 401k for most of my career now. I don’t really need the money though so I haven’t liquidated my Roth positions yet.
Since I’m not crazy about Roth IRA’s, I’d probably be supportive of someone using the money to fund their small business if they knew what they were doing and weren’t in any serious debt.
Every situation is different and needs to be handled as such. If you think you can make more by doing so and you cash out and then become successful everyone will say what a great thing you did. If it fails everyone will turn on a dime and say that was the stupidest thing you did.
Yeah I have to agree with the consensus as far as every business is different. I would have approached it a little more methodically. Financial Management is a course I’m teaching right now and that’s a scenario we covered as a matter of fact. I would try to quantify stuff like NPV’s or take a good look at the financial statements, even basic ones to see what cash flows look like. Just because a business has cash doesn’t mean it will be successful and the vice versa is also true, sales with no cash is a tough spot to be in. Evaluating risk tolerance might also be something you want to look at – especially when so many assets might already be committed to either starting or continuing this business.
Investing in a business is very different than saving for retirement. I choose to keep the two very separate, but some feel it is just savings. Of course, I would ask a lot of pointed questions abou the busines and probably ask if a loan may be more appropriate depending on the amount. It is hard to make suggestions based on a hypothesis.
Depends on who you ask. I’m pretty conservative and I still work for the man so I would have advised against it. Hindsight shows he was right, but no one has the benefit of hindsight during the crossroads. Great story!
Looks like he already made a decision even before he gave you a call On the other hand, I have seen some people who have done so and he may have considered those situations in his decision. I am not saying that it is right to cash out your Roth IRA, but we definitely have to weigh the pros and cons before making the final decision.
It is difficult to wage if you do not know the business. In the case of the friend cashing his ROTH it made sense. I would be probably scared doing it and look for different methods of financing the business rather than cashing out my ROTH (which is also my “last step” emergency account). I have a business too and yet I am not financing it using my ROTH money.
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