Is it really legal to borrow money from my Solo 401(k) Plan?
Oren T., AL
The IRS and the Internal Revenue Code permits 401(k) plan participants to borrow money from their qualified retirement plan as long as the Plan documents allow for it. Most Plan documents do allow for it as it is generally an option in the Adoption Agreement, which is the documents that adopts the Plan for the employer.
In the case of a Solo 401K Plan, prior to the 2002 Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTTRA), a self-employed individual was not able to take a loan for a Solo 401K Plan, also called an Individual 401K or Self-Directed 401K Plan.
The Solo 401K loan is a popular plan option especially over the last several years in light of the economic downturn and the tight credit markets.
In general, a loan from a 401(k) qualified plan or Solo 401K Plan is a taxable distribution unless it satisfies the following requirements:
- The loan must be repaid at a reasonable rate of interest with well defined repayment terms. In most plan documents, the lowest interest rate that can be used is Prime as per the Wall Street Journal. As of 12/21/15, Prime is 3.50%.
- The loan must be repaid within five years using a straight-line or level amortization schedule with payments to be made at least quarterly. Accordingly, one is not permitted to use interest only or balloon payments loans as all loan payments must be level throughout the five-year period. Also, there is no prepayment penalty if the loan is paid back prior to the five-year period. There is one exception to the five year rule, and that is if the loan is to be used to purchase a principal residence.
- The loan amount cannot exceed $50,000
The loan amount cannot exceed the greater of $10,000 (if your balance is under $20,000) or 50% of the plan participant’s vested account balance.
For example, if an individual is rolling $100,000 into a Solo 401K Plan, he or she can borrow up to $50,000. However, if that individual was only rolling in $60,000, then the most he or she can borrow is 50% of his or her account balance – or $30,000. In addition, if one has more than one loan outstanding, the total of all loans from the plan cannot exceed $50,000.
The Solo 401(k) Experts