Borrowing money from your Solo 401(k)

Solo 401(k)’s most touted feature is its uniquely large annual contribution limits ($46k – $102k). A lesser known feature may be just as useful for some: participant loans.

What is a participant loan?

A Solo 401(k) participant can borrow up to either $50,000 or 50% of their account value with the following terms:

  • To be repaid over an amortization schedule of 5 years or less
  • Regular payments no less frequently than quarterly
  • At a reasonable rate of interest… generally interpreted as prime rate + 1%

Such a loan may only be made in accordance with the Solo 401(k) plan documents. While most plan documents disallow this type of loan, the Unlimited® 401k offered by my company does allow it.

Under what conditions is this allowed?

Any. As long as the plan documents allow for it & the proper loan documents are prepared and executed, a participant loan can be made for any reason.

When is this useful?

This can be useful when someone is thinking about distributing money out of their Solo 401k plan for some reason. I recently talked to a man who was going to distribute his 100k IRA to pay for finishing the repairs of 2 fixer upper houses. After we spoke, his strategy was amended to instead:

  • Setup a Solo 401k plan (adopted by his business) and transfer IRA funds into it
  • Take a participant loan of $50k
  • Use the loan proceeds to finish rehabbing Property #1 (which was owned personally free & clear)
  • Do a cash out refinance on Property #1 once rehab is complete
  • Use refi proceeds to finish rehabbing Property #2 & pay back the Solo 401(k) participant loan

In his situation, it made sense to pull some equity out of Property #1 to pay for the completion of Property #2 (and the early repayment of the participant loan) because the rental income (upon completion) of Property #1 covered about 350% of its new loan payments.

The result of the new strategy

  • Avoided IRA distribution
  • Avoided $35,000 in distribution taxes
  • Paid participant loan back within a few months
  • The rental income of Property #1 will payoff its mortgage within 6 years (with maximum principal reduction payments)
  • Left $100k in his retirement account for maximum tax deferred growth

There are many other common uses for a Solo 401(k) participant loan. If a person wants to make a <$50k investment that would otherwise be a prohibited transaction, they can just borrow the money and do the investment as an individual.

What other uses can you think of?

Reader Interactions

Comments

  1. Hello Jeff,

    I was really interested in setting up a self directed IRA, that would invest in real estate, that my sons would fix up and we would flip. However, after reading through several of your blogs this appears to be prohibited transactions. Then I came across this blog.
    I have an S-Corp, where I am 100% owner. Are you saying that I could establish a Solo 401K, for the S-Corp, and then take a loan from the 401K?
    How long and involved would it be to setup a Solo 401K?

    Thanks!

Leave a Reply

Your email address will not be published. Required fields are marked *

 

© Copyright 2003 - JeffNabers.com | Terms & Conditions | Privacy Policy | Contact

 

* DISCLAIMER

The information contained throughout this web site is not a substitute for professional advice you would receive from an accountant, attorney, investment adviser, or qualified tax preparer. The information provided does not constitute professional advice nor is it conveyed or intended to be conveyed in the course of any adviser-client discourse, but is provided for informational purposes only. If you enter your email address on our web site, you are also requesting and agreeing to subscribe to our free email newsletter, and you can unsubscribe anytime if you don't enjoy it. References to investment performance of any kind is for illustration purposes only.