Solo 401k Loan: Can You Borrow From Your Retirement Plan?
Financial problems are the worst nightmares of small business owners; they eat up valuable business resources and cause setbacks. The best strategy is to act proactively and utilize all the available financial resources. Solo 401k might not be the first word that comes in your mind, but it sure does the job. The IRS allows small business owners to borrow from their retirement plan and use the funds as per requirements. A Solo 401k loan is different from a distribution in a manner that there is no penalty involved in it, whereas of a distribution stands at 10% for plan owners under age 59 ½. Keep in mind that there are still hardship withdrawals, which do not incur any penalties but are available under restrictive circumstances.
What makes Solo 401k loan perfect for small business owners?
First things first, you should avoid borrowing from your retirement savings unless there are no other available options. If you are losing your financial grounds for one or another reason, tapping into Solo 401k plan makes perfect sense, as:
- You don’t need credit check for Solo 401k loan.
- It will not affect your credit history.
- The interests will go directly into your account instead of a third party.
- You can avail loan at lower interest rates. (Prime rate plus 1%)
You can borrow up to $50,000 or 50% of the account balance, whichever caps the limit first. The borrower gets up to five years for the repayment of the loan. There has to be at least one quarterly payment to avoid defaulting on the loan.
However, you must understand the drawbacks of Solo 401k loan before taking one, starting with default distribution. For some reasons, if you are unable to meet the minimum quarterly payments, the loan will be treated as a distribution. You will have to pay taxes and penalty, which is up to 10% for individuals under age 59 ½ years. The interest that you pay for Solo 401k loan is not deductible like other interest payments. If you borrow money, it is quite likely that your contributions will decline until all the repayments are done and you will lose the benefit of tax-free growth of your investments.
The best advice for a small business owner is to review his/her financial performance periodically and prepare a road map with some emergency resources. Avoid tapping into these emergency resources unless it is necessary. After all, as a businessman, it is imperative to know what you can and cannot do.