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Using a Solo 401(k) Loan to Pay Your Taxes

Using a Solo 401(k) Loan to Pay Your Taxes

It’s that time of year again.  Like clockwork, every April the “Tax Man” comes to take his share.  If you are one of the many Americans that owe the IRS, you have options to pay off your tax bill.  One of the less common ways is using a Solo 401(k) loan to pay your taxes.  You can utilize a loan from any 401(k) plan for any reason you wish, assuming your plan allows it.  We’ll talk about how you can take a loan, the rules for taking it and the benefits as well.  If you owe taxes this year, take a few minutes to read this and know all your options.

Taking a Solo 401(k) Loan to Pay Your Taxes

As we’ve said, you can take a loan from your Solo 401(k) plan for any reason, including to pay your taxes.  However, not all plan providers allow for loans.  Therefore, you must first check with your administrator to see if a 401(k) loan is an option.  If you have an IRA Financial Group Solo 401(k) plan, the loan option is always available to you.  Now that you know that you can take out a 401(k) loan, let’s talk about the rules.  Here is a list of the general guidelines (your provider may be different) –

  • You may borrow up to $50,000 or 50% of your vested balance, whichever is less.  For example, you have $25,000 vested in your Solo 401(k).  You may borrow up to $12,500, which is half the account’s value.
  • A written loan agreement must be signed.  This will include the amount of the loan along with the repayment schedule.
  • The loan must not be more than the allowed amount that can be borrowed.  In the example above, you cannot borrow $15,000.  This is more than 50% of your balance.
  • The interest rate set by the business owner should be reasonable.  Typically, the rate is lower than banks and is usually set at Prime Rate plus  one percent.  As of 3/12/19, the Prime Rate is 5.5%.
  • Any 401(k) loan must be repaid in full within five years.  Though, it’s better to pay off the loan as quickly as you can.
  • Payments must be made quarterly and be “substantially equal.”  These payments will include principle and interest.

Benefits of a Solo 401(k) Loan

Generally, it’s not advisable to take any money from your retirement plan(s).  But sometimes, you have no other choice and a loan is your best option.  Failure to pay your income tax by the April 15 deadline will lead to increasingly higher penalties.  The major drawback of taking money out of your 401(k) plan is it lessens the earning power of your funds.  Since earning are compounded, any money you withdraw will no longer be working for you.  This is why it’s best to repay your loan as fast as possible.  There are some benefits for utilizing a Solo 401(k) loan to pay your taxes:

  • First, there’s no credit check.  You may have everything else set up to take out a traditional loan, however, if you can’t pass a credit check, you’re out of luck.  Everyone qualifies for a 401(k) loan provided you have enough funds in the account.
  • Next, is the amount of time to get the funds you need.  Once, you have filled out the necessary paperwork and finalized the loan details, you should have your money within a week.  Traditional lenders might take several weeks to get the money to you.
  • What about interest payments?  When you borrow from a bank, you pay them interest on your loan.  However, when you borrow from your 401(k), you are borrowing your own money.  Therefore, all interest paid goes back to you, via your 401(k).
  • Lastly, a 401(k) loan will not negatively impact your credit score.  Requesting a line of credit or other types of loan will show up on your report.  This may even drop your credit score up to ten points!  Since you’re borrowing your own money and not someone else’s, a 401(k) loan will not show up on your report.

Should Your Borrow from your 401(k)?

Ideally, you would never need to borrow from your 401(k) or other retirement accounts.  You should have an emergency fund set up so you have cash on hand to pay for anything unexpected.  However, since there are new tax laws for this year, many people are finding that they owe more than previous years and are not prepared.  You may file an extension to submit your tax return, however, if you owe money, you will be penalized if you don’t pay it by April 15.  Check out the IRS website for details about late payments.

In the end, a Solo 401(k) loan is not a terrible option if you are short on funds to pay your tax bill.  Do your due diligence and make sure you can repay the loan in a timely matter.  For more information and a more detailed look at the rules of the Solo 401(k) loan, click here.  If you wish to speak with a Solo 401(k) Expert, please give us a call at 800.472.0646.  We can discuss all your options when it comes to taking a Solo 401(k) loan!

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