Conventional wisdom says to never take a loan against your 401k. After all, the purpose of establishing a retirement plan is to save money for your retirement. There is also the fact that, when you remove funds from your account before you reach retirement age, you will likely incur fees for removing the money too soon. As you may already know, early withdrawal fees are designed to prevent you from removing funds from your plan. This is just one way that the government incentivizes all of us to save for retirement.
However, there can be pressing issues that force you to borrow from your plan, and there are ways to do it. But there are legitimate reasons why you may not want to do so.
Borrowing from Your Solo 401(k)
Solo 401k plans are a great way for the self-employed and small-business owners to save for retirement. They offer the benefits of a traditional 401k plan but are specially designed for entrepreneurs with lower fees and high customization.
One of the other benefits of a Solo 401k is the ability to take out a loan, should you decide to do so. These loans come with a lower interest rate and can provide cash when needed. Furthermore, when you borrow from your Solo 401k, you can do so free of tax and penalty, unlike with a traditional 401k or an individual retirement account.
Cautions Before you Borrow from your Solo 401(k)
However, borrowing money from your Solo 401k is not to be taken lightly. You can borrow up to 50% of your plan’s value (or $50,000 – whichever is less) and you’re paying yourself back, so there seems to be little potential danger. But you do need to be wary.
Repayment is Mandatory
Repayment is mandatory and if you cannot repay within the specified timeframe (five years) the loan gets treated as an early withdrawal. This comes with a fine as well as taxes due upon the amount.
Pulling money from your 401(k) means that you’re selling some of your investments. If they continue to rise in value, you won’t get the profits and the compounding power that goes with them.
You’re Selling Some of Your Investments
Interest on the loan is also not tax-deductible. So your payments are not necessarily recouping your losses until you get further into repayment. And since the funds are no longer in your Solo 401k that amount is not earning you additional money.
When you borrow from your Solo 401(k) by utilizing the Solo 401k loan, you’re essentially selling some of your investments, and if the investment increases in value, you will not gain that income.
You Invest Less Towards Your Future
Saving for your retirement is an important way to invest in the future. If your money has been removed from your Solo 401k plan, you are investing less. To get yourself back to where you were, you have to pay yourself back fully, and then begin again with saving for the future.
It is one of the many great features of the Solo 401k that you can borrow from the plan. But before you do so, make sure you’ve considered all the possible benefits and detriments that can arise when you remove funds from your retirement plan. Is the current need for cash greater than the possibility that you will not have sufficient funds during retirement? Gather all the information you need to make the most informed choice.