Internal Revenue Code Section 72(p) permits a Solo 401K Plan participant to take a loan from his or her Solo 401K Plan so as long as it is allowed based on the adopting employer’s 401K Plan documents.
A solo 401k or Individual 401K loan is permitted at any time using the accumulated balance of the solo 401k as collateral for the loan. A Solo 401K or Self Directed 401K participant can borrow up to either $50,000 or 50% of their account value – whichever is less. For example, if the Solo 401K Plan participant had $100,000 in his 401(k) Plan he can borrow $50,000. Whereas, if the Solo 401K Plan participant had only $50,000 in his Plan, he could only borrow $25,000. Alternatively, if the Solo 401K Plan participant had over $100,000 in his Plan, the Plan participant could still only borrow $50,000.
This Solo 401K Plan loan has to be repaid over an amortization schedule of five (5) years or less with payment frequency no less than quarterly. The loan could be paid monthly but not less frequently than quarterly.
The Solo 401K Loan interest rate must be set at a reasonable rate of interest – generally interpreted as prime rate as per the Wall Street Journal. As of 5/18/11, the prime rate as per the Wall Street Journal is 3.25%, which means participant Solo 401K loans are to be set at the very reasonable Interest rate of 3.25%. The Interest rate is fixed based on the prime rate at the time of the loan application.
When taking a Solo 401K loan, the Plan participant should keep the following things in mind:
- Make sure you can afford the monthly or quarterly payment. One can find a free loan calculator on the web in order to calculate the monthly or quarterly loan interest payment to make sure the loan payment can be made. Being late on a loan payment could trigger a taxable distribution on the entire amount of the loan.
- Keep track of your loan payments to make sure that all loan payments are made on time. You should all set a calendar reminder a few days before the loan payment is due. It is very important to not be late on making a Solo 401K Plan loan payment. Since all loan payments are documents by bank records, it would be hard to camouflage a late payment in the case of an IRS audit. Remember, being late on a loan payment can cause the entire loan amount to be treated as a taxable distribution.
- Most Plan documents allow you to take more than one loan so if you are not sure you can afford the loan payments, consider taking a smaller loan. You can always take an additional loan if you need it so long as the aggregate loan does not exceed $50,000 or 50% of their account value – whichever is less.
- Since Most Loan documents allow for early loan re-payment with any pre-payment penalties, paying back the loan amount if the funds are available will allow you to borrow additional funds, if needed.
- If you plan on maxing out on your annual Solo 401K Plan deferrals ($49,000 if one is under the age of 50 and $54,500 for those over the age of 50), taking a loan with a high interest rate is one strategy (i.e. 10%) will allow one to contribute additional funds to the Plan in excess of the annual imitation. One must of course make sure they can afford the loan payments as well as the interest rate not violating state usury laws.
Overall, the Solo 401K Plan Loan is a great tool for any self employed business owner seeking immediate funds for their business or for any personal need. Whether one needs money to start a business, finance an existing business, pay off a personal credit card, cover a mortgage or rental payment, pay for a medical expense, or even to take a vacation or buy a car, the Solo 401K Plan loan provides a Solo 401K Plan participant with quick and cheap access to available funds. Why pay a bank or credit card company interest on a loan when you can pay it to yourself and watch your retirement funds grow at the same time.