As a company that has helped tens of thousands of individuals and small businesses in the United States establish and administer Self-Directed IRAs and Solo 401(k) plans for over 12 years, the COVID-19 pandemic has created more panic than I have ever seen. I must have spoken to 250 clients since March 15 that have asked questions about ways to tap into their retirement funds to help pay businesses expenses. Almost all of these clients echoed the same words –thank God I started a retirement plan, because without these savings, I would have no savings and no opportunity to keep my business afloat, until the Paycheck Protection Program (“PPP”) funds were made available.
The Solo 401(k) Plan Saved My Business
This is the story of Pamela W, a Solo 401(k) client of IRA Financial since 2012. Pamela had a small business that she ran with her husband. The business had no full-time employees other than Pamela and her husband. I spoke to Pamela towards the end of March 2020, days after the PPP loan program was announced, which would offer her a loan equal to 2.5 times her monthly payroll, which could be ultimately forgiven.
Pamela was concerned that the PPP loan program would not cover the self-employed and she would not be eligible to participate, although she mentioned she believed she would be eligible through the business. She also mentioned that she had approximately $104,000 in the Solo 401(k) plan, which she had built up since 2012. Of course, Pamela was very proud that she was able to save so much in just 7 ½ years. Pamela started the Solo 401(k) plan from scratch and through consistent annual contributions and some smart investing, she was able to accumulate over $100,000.
She wanted to know what the most tax efficient options for tapping into her Solo 401(k) plan to help pay for business expenses, such as rent and credit card bills in light of the COVID-19 pandemic. Pamela mentioned that the 401(k) plan was her really only source of savings and how happy and relieved she was that she decided to establish the plan. I remember her specifically saying that she would be in deep trouble if she never set up the plan because the money she saved would have most certainly been spent on travel and leisure purchases.
The CARES Act
I mentioned to Pamela that because she had done such a great job saving through her Solo 401(k), she had a few really good options based on the CARES Act.
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 it boosts unemployment insurance payouts and aims to send relief checks to many Americans. The Act included many important provisions to help Americans who lost their jobs due to the COVID-19 virus, including several specific to retirement account holders.
- $100,000 penalty-free distribution: If one has been impacted by the COVID-19 pandemic, one can take a penalty-free distribution from the Solo 401(k) plan of up to $100,000, without penalty. In addition, the tax due on the distribution would be due in three years and no tax or penalties would apply if the entire amount of the distribution was returned in the three-year period. Essentially, the IRS is providing the plan participant a tax- and penalty-free three-year loan. I explained to Pamela that without this CARES provision, she would likely not be able to take a distribution from the plan, since one needs a plan triggering event to take a plan distribution. Usually, this occurs when the participant reaches the age of 59 ½ or separates from the employer.
- $100,000 401(k) Plan Loan: The CARES Act increased the 401(k) plan loan amount from $50,000 to $100,000. Under prior law, one would only be able to borrow from the plan the lesser of $50,000 or 50% of their account value. Under the CARES Act, the 50% requirement was removed. In addition, no loan payments are due in 2020, making the loan a six-year loan. The lowest interest rate that can be used is Prime, which is 5.50% as of August 30, 2022. Best of all the, loan proceeds can be used for any purpose and you are essentially paying yourself back.
In order to take advantage of the above referenced CARES Act provisions, one would need to show:
- An individual was diagnosed with SRS-COV-2 or COVID-19 by a test approved by the CDC
- Whose spouse or dependent was diagnosed with one of the two diseases
- A participant or business owner experienced adverse financial consequences as a result of being quarantined, furloughed, having reduced hours, or cannot work due to unavailability of childcare
Distributing from a Solo 401(k)
Pamela mentioned that she has not tested positive for the COVID-19 pandemic, but has experienced adverse financial consequences because her business has effectively been shut down because the state did not deem it essential. She liked both options and mentioned that she would probably elect to go with the penalty-free distribution under the CARES Act. She also mentioned that she was interested in taking about $35,000 to begin with, to help cover various business expenses.
I also mentioned to Pamela that the PPP loan program would be available for her and her husband as employees of the business. In fact, even if they were deemed self-employed, the PPP loan would be available equal to the 2019 of the businesses net profit divided by 12. This amount multiplied by 2.5 equals the PPP loan amount. In other words, the PPP loan is roughly ten weeks’ worth of net profits. Whereas, if Pamela received a W-2 from the business, the PPP loan amount would be 2.5 times the monthly payroll. In addition, so long as 60% is used for payroll, the total loan amount can be forgiven. In fact, the amount used for payroll would also be tax deductible.
WATCH THIS: How Do I Report CARES Distributions?
Pamela mentioned that had applied for the PPP and was still awaiting approval. I mentioned that she should try applying with multiple banks because there are still funds available in the program. I also talked to Pam about the SBA’s Economic Injury Disaster Loan, which will provide her with an automatic $10,000 grant.
Pamela was relieved that she had some really good options to get liquidity for her business. She was very frustrated that her business was forced to close and her landlord is not being very reasonable in terms of rent reduction. Pamela was so grateful that she had set up a Solo 401(k) plan and now had options to help save her business. She actually suggested that I write a blog and spread her message that saving for retirement by establishing a Solo 401(k) plan was the best financial decision she ever made. Without the plan savings, her business would certainly be doomed.
Pamela’s story is a good example of the power of retirement savings. Your money grows faster in a retirement plan because of the power of compounding interest. It’s basically simple math – your money grows faster when the income it generates is not subject to annual tax. By saving in a retirement plan versus a taxable savings account, Pamela was able to boost her level of savings, which ended up helping her business navigate the COVID-19 financial crisis.
As written by Adam Bergman, President of IRA Financial