Financial Roulette

Entrepreneur, June, 2000 by David R. Evanson

Is borrowing From your IRA a healthy risk or a tragic mistake?

Courtney McCain, 25, is at once an unlikely and highly likely entrepreneur. She's got half a college degree. She married an Air Force man and moved to a remote base in the Midwest. After being re-stationed on the East Coast, she separated from her husband and moved nearer to family and friends, where she went through a string of administrative assistant jobs. She excelled at each job but was ultimately bored and burned out. Now an assistant account executive with a public relations firm, McCain is on a decidedly professional track.

Public relations might be her calling ... but, then again, it might not be. "I know that I've got the brains and the talent to be a success," she says, "but it has to be on my terms. My big challenge is to find out what it is that I'm good at doing. Successful people aren't successful just because they're smart. I think they're successful because they've pursued things in which they have natural talent."

For McCain, what seems to come naturally is consumer sales. And to test the waters, she's taken on a distributorship for Mary Kay Cosmetics in addition to her 9-to-5 routine. There are few downsides. Besides, if this is her true calling, or at least a calling, there's a lot of upside potential.

But when opportunity comes knocking, it usually has a price. As a distributor, McCain buys her makeup products directly from the company and marks them up, generally 100 percent. To make, say, $2,000 in bales, she must fork over 1,000 upfront. To make $10,000, it costs $5,000 upfront. In short, during her nascent career as an entrepreneur, McCain has come up against one of the fundamental challenges of business: It takes money to make money Unfortunately for McCain, due largely to her age and a near-Bedouin existence over the past three years, she doesn't have any money.

The issue cuts deeper than simply not having risk capital on hand for a new venture. For hundreds of thousands of would-be entrepreneurs like McCain, there's no access to funds, either. There's nary a bank in the country that would lend her a dime. She can get a debit card, but not a credit card. And in McCain's case, a fierce streak of independence keeps her from asking friends and family for a loan.

WORTH THE RISK?

All this is why an idea as cockamamie, ill-advised and downright dangerous as taking money from your IRA, in certain circumstances, isn't such a bad idea after all. Although people will call you crazy if you even think of taking money out of an IRA to fund a business, there can be a gaping hole in the logic behind those people's complaints. In McCain's case, the lapse in the logic is that her IRA, funded with $1,000, is just about the only asset she has. She can scratch her head wondering where to get $1,000, or she can roll the dice, get on with life and perhaps make a lot more money that she ever could playing it safe.

Here's another reason for McCain to tap her IRA: Entrepreneurs who don't put themselves in some form of jeopardy to get their businesses off the ground often preclude the participation of other investors. Banks, family members and angel investors don't like to be the only ones at risk in the deal. The thinking goes, "If you're not willing to risk it, why should I?" Entrepreneurs who do take these kinds of risks often find that financial partners, would be or otherwise, are much more receptive to financing proposals.

McCain, though not totally comfortable with the idea of drawing on her IRA, is doing it anyway. "I see it as a way to accelerate the process," she says. "I can plod along, or I can put my money where my mouth is." And, in truth, while raiding one's own pension fund simply can't work in a lot of deals--i.e., never use it to fund biotech research and development--it works beautifully for the rapid inventory turnover business McCain has chosen.

Once McCain finally gets her hands on her money, she can use it to get $1,000 worth of inventory. If all goes well, this $1,000 in wholesale goods will generate $2,000 in retail sales. As a result, she only has to sell half her inventory in 60 days and get it back into her IRA before she'll suffer any penalties. In fact, the wiser entrepreneurs might suggest that putting herself under the gun like that is the best thing that McCain can do to jump-start her business. The real beauty of the plan is that if she sells out her inventory and makes $1,000, she can finance her next purchase of inventory with profits rather than her nest egg. In short, by taking on some risk, McCain gets her assets to work for her.

STICKY RED TAPE

You can't do any of this without the government getting into the act, however. Remember, IRAs let your money grow tax-deferred. To the fed's way of thinking, because they're allowing you to avoid capital gains taxes for some 60 years with your IRA, they have a say-so in what happens to the money in the meantime.

The rules and regulations pertaining to IRAs are covered in IRS publication 590, a mind-numbing tome with some 80 pages. But, according to Mike Busse, a senior vice president of Harris Trust & Savings Bank in Chicago, the mechanics are quite simple: "You can withdraw the assets from one IRA and use the funds for 60 days before redepositing them without creating a taxable event."