The recession and the reluctance of the banking industry, as a whole, to make loans to businesses because of the banks’ own financial difficulties has forced cash starved small businesses to look for other sources of cash. Oftentimes, small business owners are tempted to look to their retirement accounts as a source of funds. However, there are many adverse consequences that can result from that approach. 

In the situation where a small business is at risk of surviving, the owner’s use of retirement funds in an attempt to keep the business afloat may only serve to convert assets that could not be attached by creditors or which would be exempt in the case of a bankruptcy filing to assets that are attachable or that are not exempt. Under federal bankruptcy law and Ohio law, individual retirement accounts and Roth IRAs are free from creditor attachment and exempt assets that can be maintained for the debtor’s benefit in the case of a bankruptcy filing so long as contributions have not been made to avoid the claims of creditors.

In addition, there are severe tax consequences for early withdrawal of retirement funds. If an owner withdraws funds from his or her IRA account before the age of 59 ½ years of age he or she must pay a penalty to the Internal Revenue Service equal to 10% of the amount withdrawn. Moreover, the money withdrawn is subject to income taxation, both federal and state. Thus, the amount withdrawn would need to be much larger than the amount needed in order to net the amount that is required.

Small business owners often make the mistake of withdrawing retirement funds in order to provide funding for their business for a few months, only to see that business become bankrupt. In the end, they lose their retirement account, their business, and incur an income tax liability that they may not be able to pay.

Despite the present financial climate, many community banks remain willing to make small business loans. And, Small Business Administration ("SBA") loans that may be obtained from some of those banks under appropriate circumstances may present an alternative. Also, seeking additional investors in the business may prove to be an option, particularly if the business is a high technology startup.

A small business owner should always seek professional advice on matters pertaining to funding business operations, particularly in the present economic climate.