Laid off at 56. Should I roll my 401(k) into a franchise?

The question

An illustrative letter.

The answer

My dear, being let go at 56 after years of work is a hard blow, and it is natural to want a fresh start you control. A franchise can be a good second act for some people. But the pitch you heard leaves out its most important part, and with your whole retirement at stake, it deserves a slow, careful look.

Can a 401(k) really fund a business tax-free?

The broker is describing what is called a rollover as business start-up, or ROBS. You form a new corporation, the corporation sets up its own retirement plan, your 401(k) rolls into that plan, and the plan buys stock in your corporation. Done correctly, it can avoid immediate tax and the early withdrawal penalty. It is permitted, but it is complicated, and it comes with ongoing filing duties for the new plan.

The IRS studied these arrangements in a compliance project. It found some success stories, but most of the businesses had either failed or were on the road to failure, with high rates of business and personal bankruptcy, liens and dissolved corporations. Some owners lost both the business and the retirement savings they had spent years building, in some cases before they had even opened their doors. Large recurring promoter fees played a part in some of those losses.

Do most franchise owners really thrive?

That is a claim to test, not to trust. Under the Federal Trade Commission's Franchise Rule, any statement a franchisor makes about sales, income or profits must appear in Item 19 of its Franchise Disclosure Document. If a figure is not in Item 19, no one should be telling it to you. Item 20 shows how many outlets opened, closed and changed hands, and lists current owners along with the names and contact details of those who have left. High turnover tells its own story.

How do I check a franchise properly?

• Get the disclosure document and take your time. By law you must receive it at least 14 days before you sign anything or pay any money. Take longer if you need to.
• Read Items 19, 20 and 21 first. The earnings claims, the turnover, and the franchisor's audited financial statements.
• Talk to owners, including ones who left. Ask what they really earned, how long it took to break even, and whether they would do it again. Speak to at least ten if you can.
• Hire your own lawyer and accountant. Not the broker's. A franchise broker is often paid by the franchisor when you buy, which shapes what you are told.
• Count the whole cost. The franchise fee, build-out, equipment, ongoing royalties and enough working capital to survive a slow first year without pay.

Are there safer ways to pay for it?

If, after all that, the franchise still looks strong, consider putting in only part of your savings and borrowing the rest through a bank or an SBA-backed loan. Then if the business struggles, much of your retirement survives. Keeping money in reserve also lets you weather the slow months that nearly every new business faces.

What income do I have in the meantime?

Because you left your job in or after the year you turned 55, you may be able to take money from that employer's 401(k) without the 10 percent early withdrawal penalty, though income tax still applies. That exception covers the plan of the employer you just left, not IRAs, so rolling the money into an IRA would give it up. File for unemployment benefits too, and look closely at any severance offer. Your plan administrator can confirm the details for your plan.

How much of my retirement is too much to risk?

No law sets the number. But consider your timeline. At 56, you may have ten working years to rebuild if something goes wrong, and fewer if your health or the job market do not cooperate. Your $250,000 may need to support you for 30 years after that. Many people decide in advance how much they could lose and still retire with dignity, and they invest no more than that in any single venture.

What if I still want to own a business?

Then go in with your eyes open. You might work for a franchise in the system for a few months before buying, start smaller, or buy an existing outlet with a track record you can examine. Each lowers the guesswork.

A second act should add to your life, my dear, not gamble it. Read every page, talk to the people who left, and protect the core of the savings that took you a working lifetime to build.

One thing to do this week

Ask for the franchise's disclosure document, read Items 19 and 20, and list five former owners to call.