Nearly all those who start small businesses need to access funding at some point, either to launch the business, fund an expansion, or weather a difficult period. There are numerous sources for small business capital, including traditional bank loans, microloans from various organizations, venture capital, or the Canadian Small Business Financing Program. One funding option that doesn’t require relinquishing equity interest in your business or incurring debt is financing your small business using your retirement account funds. This option carries its own potential advantages and disadvantages.

Accessing Retirement Funds

The two principal retirement accounts in Canada are a Registered Retirement Savings Plan (RRSP) and a Tax Free Savings Account (TFSA). An RRSP offers the advantage of tax-deductible contributions, but it carries substantial tax penalties, which range from 10 to 31%, for early withdrawals. A TFSA is a flexible savings account, which is similar to a Roth IRA. It doesn’t offer an up-front tax advantage, but it allows for tax-free investment earnings and does not carry the withdrawal penalties that an RRSP does. Any withdrawals can be replaced in a TFSA in later years, within contribution limits. Given the difference in treatment of withdrawals, if you have funds in both an RRSP and a TFSA, funding your small business with money withdrawn from your TFSA generally poses less of a financial risk.

Retirement Account Funding Advantages

The biggest advantage gained by using your retirement money to provide capital for your small business is that you avoid incurring debt. If your business idea works, the profits are all yours. In the worst case scenario of your business failing, while you will lose whatever retirement money you withdrew, at least you won’t have increased your debt burden. If you had instead chosen to take out a bank loan to fund your business, you would still have the obligation to pay back the bank.

Retirement Account Funding Disadvantages

The potential disadvantage of retirement account funding is that utilizing this financing option exposes you to the double risk of ending up with a failed business and an exhausted retirement account. You can minimize this disadvantage by withdrawing sufficient funds to finance your business while still leaving a substantial sum of money in the account. For example, the downside would be lessened if you could finance your business with $50,000 withdrawn from your TFSA while still leaving $100,000 in the account, as opposed to making a $50,000 withdrawal that effectively wipes out the total account balance.

Making an Informed Decision

To make a rational, informed decision on whether to withdraw money from your retirement account to finance your small business, you should consider the risk/reward calculation of how much money you can potentially gain by investing in your business versus how much you might lose if the investment doesn’t work out. The level of risk involved is another factor to consider. Using your retirement money to launch a new, unproven business idea carries significantly greater risk than using retirement funds to finance an expansion of an already successful, profitable business. Accessing retirement account money is certainly a business financing option to consider, but you should carefully weigh the risk of doing so against other possible options, including using funds from a brokerage account or obtaining a home equity or refinancing loan.