Lend to Yourself
401(k) plans allow for participant loans. This means that you can borrow from your account without taxes or penalties, and use the funds for any purpose. For many self-employed entrepreneurs, this access to capital can be a means to help grow the very business you are using to sponsor your plan.
401(k) Loan Guidelines
The rules for 401(k) loans are determined by the IRS and plans such as the Safeguard Solo 401(k) must adhere to those rules when designing the participant loan policy.
- You may borrow the lesser of 50% of your participant account value or $50,000.
- The loan is for a 5-year maximum term. If the loan is to be used for the purchase of a primary residence, the term can be extended.
- The interest rate is set at prime +2%
- Payments must be made on an amortized basis, at least quarterly.
- You may take up to 3 loans at any time, up to the borrowing limit.
- There is no penalty for pre-payment of a loan.
- Loans are participant-specific. If both you and your spouse have savings within your Solo 401(k), each of you can borrow up to your respective limit.
- If you fail to repay the loan, it is considered a distribution and taxed accordingly, including early distribution penalties if applicable based on your age.
As the trustee and administrator of your Solo 401(k) plan, you manage the participant loan process. Your plan documents will include everything you need to create the proper paper trail, including a loan document and promissory note. There is no 3rd party approval or review required, and no additional fees for using the loan feature of your plan. When you take out a loan, you will simply write a check from the plan trust account to yourself. You then just need to be sure to make monthly or quarterly payments back into the plan account in accordance with the terms of the loan. Your dedicated Safeguard Advisor can help you put your loan in place.
401(k) Loan Example 1
Steve setup a Solo 401(k) sponsored by his home construction and remodeling business. He rolled over $150,000 from prior retirement plans.
Steve’s borrowing limit is $50,000.
Steve borrowed $40,000 at 5.25% from his plan to fund the rehab costs on a flip project he was doing outside of his 401(k) plan. He made monthly payments to the plan of $759.44 for 4 months, at which point he sold the home and returned the remaining principal balance of $37,646 to the plan. His plan made $684.61 in interest on the loan.
Steve personally made $35,000 on the flip project, which was taxable income to him since it was outside the 401(k) plan. By borrowing from the plan, he was able to self-fund his flip and did not need to incur the much higher borrowing costs of a hard money loan.
At the same time, Steve used most of the other $110,000 in his Solo 401(k) to purchase a rental property that produces tax-sheltered rental income to his plan each month.
401(k) Loan Example 2
Jade recently left a corporate job to start her own consulting business. She had a 401(k) worth $90,000 from her prior employer that she rolled over into a new Solo 401(k) sponsored by her new business.
Jade’s borrowing limit is $45,000 (50% of $90,000).
Jade borrowed $15,000 from her plan to cover startup costs of the business and provide a little cushion go get her through the first few months as she built her client base and billable hours. The loan was at an interest rate of 5.25% and she made quarterly payments of $854.37 as required.
Jade knew that $15,000 would probably not get her through until her business was self-supporting, but she started with a lower loan amount to keep her payments low.
After 6 months, Jade borrowed another $15,000 on a 2nd loan. Her quarterly payment for both loans was now $1708.74, but the business was already starting to generate earnings so she could afford this amount.
At the end of the first year, Jade was making enough money to cover her 401(k) loan payments and draw some earnings from her business personally. Her 401(k) loan had helped her start her business.
While she was growing her business with a portion of her Solo 401(k), Jade also invested $30,000 into a crowdfunded real estate venture and kept a portion in a few mutual funds so there would be some liquidity in case her business took longer to get started and she needed a small additional loan.
Consider the Opportunity Cost
When considering a loan from your Solo 401(k), you want to weigh the benefits of that access to capital compared to what your plan could earn otherwise. Prime rate +2% is a moderate rate of return for your plan, and would be about 5.75% as of this writing in early 2017. If you could be making hard money loans from your plan to other investors at 2 points and 15% interest, that is a pretty significant potential return you are giving up to access your plan funds for your own purpose.