A cottage industry, made up of a few small companies and a bevy of independent contractors, has sprung up to help entrepreneurs turn their 401(k)s and other tax-deferred accounts into capital. The firms, which generally charge $4,500 to $7,500 for their services, are taking advantage of an unpublicized tax law that allows individuals to invest their retirement funds in a company.
Here’s how it works. An entrepreneur, aided by the outside adviser, creates a corporation. The newly formed entity starts a 401(k) plan, and an individual rolls over existing retirement funds into the account. Under 401(k) rules, the plan can purchase shares in the corporation—money that can be plowed into a small business that sells a product or service. Those deals are considered investments, which is the key. By investing the money rather than withdrawing it, entrepreneurs avoid triggering a penalty that amounts to 10% of the assets.