The Individual 401k retirement plan opens a world of investment options. Also known as the Individual k or Solo 401k, the self-directed plan from Sense Financial has virtually unlimited potential for investing in almost any investment class, such as notes, real estate, tax liens, tax deeds, and private businesses. This investment capability is one of the advantages of the plan.
Purchasing Notes Using the Individual 401k
The IRS allows the plan to be used to make loans and purchase promissory notes from third parties. As long as the transaction does not violate the Solo 401k rules for prohibited transactions and disqualified persons, the note can be purchased using the plan.
Using the plan to purchase a note is considered an investment. This differs from the Solo 401k loan feature, which allows the owner of the plan to borrow up to $50,000 from the account. This is a loan from the account to the owner; a promissory note is a loan from the account to a third party. With a note, the Individual 401k is the lender and beneficiary of the loan.
Setting the Terms
When purchasing a promissory note, the owner and trustee of the plan determines the terms of the note. These terms include:
- Loan amount or principal
- Interest rate- simple or compound
- Maturity date
- Payment due dates
- Type of loan- secured or unsecured
- Guidelines for dealing with default of the loan
The owner/ trustee is responsible for the safekeeping of the investment and thus determines the terms of the note. He or she is also responsible for drafting the promissory note document. This document legally binds the borrower to repay the loan.
If the note is secured, a second document must also be drafted which secures the promissory note to collateral, such as real estate or equipment. This asset securing note can be drafted by the owner of the plan or by a hired loan servicing agent. If the borrower fails to repay the loan, the Individual 401k account can foreclose on the property used in securing the note.
Payments are made according to the determined schedule to the Individual 401k account. These payments can be collected and deposited into the account by the owner/ trustee or the loan servicing agent. Payments on the note made to the Individual 401k protect the account from being taxed.