By Jim Cramer and Wally Konrad, former senior editor for Smart Money magazineNEW YORK ( TheStreet) -- The ads are peppered throughout the Internet: "Buy or start a small business using your retirement savings!" "Finance a business or a franchise from your 401(k) -- without debt!" Players like Guidant Financial and IRA Financial Group have armies of advisers waiting to tell you how to use a little known tax loophole to redirect your nest egg into what may be one of the riskiest investments ever: a small business. The tax situation works like this. If you invest your 401(k) funds from a former employer to buy or start a business, you will be able to do so without the taxes and penalties associated with early 401(k) withdrawals. Instead you roll over the money into the business's retirement plan and use that money to invest in stock in the company. The rollover part means you avoid taxes and penalties. At the same time, buying the stock provides cash to start or buy the business.
In other words this probably isn't the way to start a Pinkberry franchise or the corner hardware store. "Small business is extremely risky, and most people shouldn't use retirement funds for risky investments," says Bill Harris, CEO of Personal Capital, an online financial adviser service. Even Guidant's Ames agrees this isn't for every budding entrepreneur. He tells the story of one client who used her funds to open a dry cleaner, only to sell the business and take a loss a short time later. A loss in this case most likely means she lost a good chunk of her retirement savings. Bad choices like these, however, are conveniently not Guidant's problem. Says Ames: "Our work is designed to weed out any compliance issues on the tax part. That's what we're good at. We are not small business finance experts. We don't advise on what transactions to invest in or not invest in."