The closure of hundreds of banks over the last few years have ushered in stricter lending practices. Financial institutions are more hesitant to lend money, making it harder for small business owners and self-employed to obtain loans.
The Solo 401(k) loan feature allows participants to borrow from the Solo 401k plan. This capability gives small business owners and self-employed an available source of funding at a reasonable interest rate. This loan can be taken from the account for any reason and for any purpose.
Choosing the Solo 401(k) Loan Amount
The amount of the loan depends on the balance in the retirement plan account. The loan can be up to 50% of the account value with a maximum amount of $50,000. The account balance serves as collateral for the Solo 401(k) loan. Other retirement accounts, such as the traditional 401k, 403b, SEP IRA, and traditional IRA can be easily rolled over to the Solo 401k. This raises both the value of the account and the amount that can be borrowed from the account.
The Solo 401k account is the lender of this loan. Once proper paperwork is prepared, the loan can be made immediately. The participant can simply write a check from the account to himself. There are no credit qualifications needed for the loan.
Taking a loan from the Solo 401k allows account funds to be used without being subject to Internal Revenue Code Section 4975 for prohibited transactions. It is not an in-service distribution of the fund; it is a loan from the plan to the participant and thus is not subject to distribution penalties.
Opening Up the Possibilities
The possibilities of the Solo 401(k) loan are endless. It may be used for making investments, consolidating debt, lending to a third party, or paying college tuition, to name a few. For the self-employed and small business owner, the loan gives access to account funds for any use.
The loan is free from taxes and penalties if it is paid according to its conditions and amortization schedule. It must be repaid within 5 years and can be extended to 10 or 15 years if the loan is used to purchase the participant’s primary residence. Loan payments must be made at least quarterly. The loan includes the principal plus a reasonable interest rate, which is typically defined as Prime plus one percent. All loan payments are made to the Solo 401k account. Failure to repay the loan according to its terms may result in a loan default, triggering appropriate taxes and penalties.
The Solo 401(k) loan feature gives a powerful option to the self-employed and small business owners. It gives participants the power to choose how and when to use account funds.