Should You Tap Your Retirement Savings to Start a Small Business?

The quick answer? It depends on your age and savings level.

If you've been looking to start a small business, you're in good company. In his most recent State of the Union Address, President Biden announced that over the past two years, a record 10 million Americans applied to start a new small business.

But the costs of getting a new business off the ground can be substantial. And while you may be able to take out a loan to finance yours, you might also run into issues qualifying for one.

Even if you are able to get a small business loan, or a personal loan whose proceeds you use to get your venture off the ground, you risk getting stuck with an expensive interest rate due to borrowing rates being up these days across the board. And so you may be thinking of tapping your retirement savings to get your business up and running instead.

But is that a good idea? The quick answer is that it really depends on two key factors -- your age and your savings balance.

Why your age matters

There are tax breaks associated with putting money into an IRA or 401(k) plan. Because of these, the IRS has the right to impose penalties for taking withdrawals prior to age 59 ½.

Now there are a few exceptions to this rule. IRAs, for example, do allow a limited penalty-free withdrawal to buy a first-time home. But for the most part, if you're not yet 59 ½ years of age, you'll be penalized for tapping your IRA or 401(k) plan if you remove funds to start a small business. And since that penalty will equal 10% of the sum you remove, that's a penalty worth avoiding.

However, if you're old enough to access your retirement savings for any purpose without incurring a penalty, then tapping your IRA or 401(k) may not be a bad choice -- provided you're sitting on a nice amount of savings.

Read more: The Best Business Checking Accounts for Small Businesses

Why your savings balance matters

The purpose of an IRA or 401(k) is to ensure that you have enough money to pay your living costs during retirement. And so if you raid your retirement savings for a different purpose, like starting a small business, you'll leave yourself with that much less money to cover your living expenses later in life.

That's why the amount of money you have in savings should be a factor when determining whether to tap your IRA or 401(k) or leave it alone. If you have a $2 million nest egg and need $50,000 to start a small business, and you're already 59 ½ or older, then taking that withdrawal actually makes a lot of sense. Not only is it a small portion of your total savings balance, but if you invest that money in a business you run before and during retirement, you might set yourself up with a reliable, robust income stream.

But let's say you need $50,000 to start a small business and you only have a $200,000 nest egg. While it's great that you were able to save that much, if you're already pretty close to retirement and don't see that balance growing all that much, then it's probably not a great idea to withdraw 25% of your total savings. Doing so might mean risking financial difficulties as a retiree.

Running a small business can be a rewarding experience in more ways than one. But think carefully before tapping your retirement savings to get it going. Depending on your age and savings balance, you may want to look at other options for funding that venture, like taking out a business or personal loan.