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Borrow From a 401(k) – CARES ACT

Borrow from a 401(k)

On March 27, 2020, the President signed the $2 trillion stimulus package called the CARES Act – the Coronavirus Aid, Relief, and Economic Security Act.  The primary purpose of the Act is that boosts unemployment insurance payouts and aims to send relief checks to many Americans. The CARES Act included many important retirement related provisions that were designed to provide retirement account holders with needed capital and liquidity including extra funds available to borrow from a 401(k) plan.

Key Points
  • Millions have been affected by COVID-19
  • The CARES Act is a stimulus package designed to help all Americans
  • The 401(k) loan can help you get funds you need right away

The Solo 401(k) Plan Advantage

The Solo 401(k) Plan, also known, as the Individual 401(k) or Self-Directed 401(k) Plan, is an IRS approved type of qualified retirement plan which is suited for business owners who do not have any employees, other than themselves and perhaps their spouse. The Solo 401(k) Plan is best suited for business owners who do not have any employees, other than themselves and perhaps their spouse.

The determination of whether your 401(k) plan allows for a loan feature is based on the plan documents.  Not all Solo 401(k) plan documents offer the loan feature.  In fact, many plans provided by banks and financial institutions do not include the loan feature. Hence, it is important to ask about the plan loan feature before establishing your Solo 401(k) plan.  This is the same for alternative asset investments or Roth contributions.  Those options are made available by some plan document providers, such as IRA Financial, but this is not the norm.

If your Solo 401(k) plan documents include a loan option, pursuant to Internal Revenue Code Section 72(p), a plan participant can borrow up to either $50,000 or 50% of their account value – whichever is less. This loan has to be repaid over an amortization schedule of five years or less with payment frequency no less than quarterly. The interest rate must be set at a reasonable rate of interest (Prime). The Prime Interest Rate, as per the WSJ, is 5.50% as of August 30, 2022.

The Solo 401(k) plan is a great way to get tax-free use of your 401(k) plan funds to use for any purpose without paying tax or penalty.  The best part is the loan feature allows a plan participant to use up to $50,000 for any purpose, personal or business, without triggering the IRS prohibited transaction rules and the interest and principal you pay back from the loan goes back to the plan, helping increase the value of the plan.

Borrow from a 401(k)

In light of the economic fallout as a result of COVID-19, the CARES Act increased the 401(k) plan loan from $50,000 to $100,000, without regard to the 50% account value threshold.  Also, all 401(k) plan loan payments are suspended for 2020. Of course, one would need to have access to a 401(k) plan loan feature and take the loan out prior to December 31, 2020.  In order for a plan participant to avail themselves of the CARES Act loan provision, one would need to show:

  • an individual who is diagnosed with SRS-COV-2 or COVID-19 by a test approved by the CDC,
  • whose spouse or dependent is diagnosed with one of the two diseases, or
  • who experiences adverse financial consequences as a result of being quarantined, furloughed 

The advantage of taking a loan from a Solo 401(k) plans versus an employer 401(k) plan is that you do not need the consent of a third-party administrator to consent to the loan request.  You can offer consent as the trustee and plan administrator of the Solo 401(k) plan.  Whereas, in the case of a 401(k) plan where you are just an employee and not an owner, your plan administrator will need to offer the CARES Act loan feature and consent to your loan request.  The plan administrator is under no obligation to do so. In fact, there are many examples of businesses not offering the CARES loan feature to their employees.

There are many advantages of using a Solo 401(k) plan loan:

  • •Tax-free & penalty free use of funds
  • •Ability to use loan funds for any purpose and also grow your plan
  • •Interest paid back to plan
  • •5 years or 15 years if used to purchase primary residence
  • •Low interest rate
  • •Pay back at least quarterly
  • •Flexible corrective measures available
  • •Plan administrator (you) approve loan
  • •Funds can be used for any purpose

If you have been impacted by COVID-19, taking advantage of the CARES Act loan provision may be a tax efficient way to secure needed capital or liquidity in this difficult time. Remember, if you borrow from a 401(k), you must pay it back in a timely matter or risk getting hit with a big tax bill.

If you have any questions about the 401(k) loan feature, please give us a call at 800.472.0646!


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