The Freedom of the Individual 401k Plan to Invest in Notes
Open the world of investment options with the Individual 401k plan. Plan holders can invest their funds into almost any investment class, including notes, real estate, tax liens, tax deeds, and private businesses. This investment capability is one of the greatest advantages of the plan.
Using the plan to purchase notes
The plan can be invested in notes. The plan can make loans and purchase promissory notes from third parties.
Make sure that the transaction does not violate Solo 401k rules for prohibited transactions and disqualified persons. The IRS has established these rules to ensure proper use of the plan. And as trustee, fiduciary, and plan administrator, you are responsible to ensure that the investments of the plan do not go against IRS rules.
From the plan’s standpoint, notes are an investment. A promissory note is a loan from the plan to a third party. And in this case, the plan is both the lender and beneficiary of the loan.
Setting the terms of the note
The owner and trustee of the Individual 401k plan determines the terms of the promissory 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
Because you are responsible for the safekeeping of the investment, you determine the terms of the note. Remember that the note must be in the interest of the plan. Because you are fiduciary of the 401k, you are responsible to act in a manner that benefits the plan.
You are also responsible for drafting the promissory note document. This document legally binds the borrower to repay the loan. You may choose to draft this document, or you may hire a loan servicing agent.
In addition, consider structuring this as a secured note. This way, if the borrower fails to repay the loan, the Individual 401k can foreclose on the property used to secure the note. If the note is secured, you must also draft a second document which secures the promissory note to collateral, such as real estate or equipment.
The borrower must make payments according to the determined schedule. You can collect and deposit these payments into the 401k. Or you can hire the loan servicing agent to do so. Payments on the note made to the Individual 401k plan protect the account from being taxed.
Notes are just one example of the many investment options available with the 401k. Contact us to find out if you’re eligible for the plan or how to structure an investment properly.
