As you may have heard, the ability to borrow against a Solo 401(k) is one of the benefits of holding such a retirement account.
Individual Retirement Accounts (IRAs) do not offer such luxuries. But are Solo 401(k) loans worth it? For what purpose do people take them out? How much can you borrow?
Financial experts advise using a Solo 401(k) loan as a last resort, but it’s worth considering if you’re opening this type of retirement savings account and you want to enjoy the full range of benefits.
How Much Can You Borrow in a Solo 401(k) Loan?
Once you begin accumulating an account balance in your Solo 401(k), you can borrow 50% of your account value or $50,000 – whichever is less. You can have multiple loans out, but your total outstanding balance may not exceed 50% of the vested balance or $50,000 over a 12-month period.
Can You Ever Borrow More Than 50% of a 401(k) Loan Balance?
IRS rules are subject to change at any time. For instance, from March 27 through September 22, 2020, during the Coronavirus pandemic, loans worth the lesser of 100% of the account balance or $100,000 became available.
How Long Are 401(k) Loan Terms?
You then have up to five years to repay yourself back, with payments made on a quarterly basis. The term can be longer if you’re borrowing for a payment on a primary residence mortgage or if you refinance it.
What Is the Interest on Solo 401(k) Loans?
The interest rate must be set at a “reasonable” rate – which is typically the prime rate. As of October 2020, the prime rate was 3.25%–which is much lower than credit cards and other types of money you might borrow.
Why Might Someone Borrow From a 401(k)?
People borrow from their Solo 401(k)s to:
- Consolidate debt
- Pay for college expenses
- Cover unexpected emergencies
- Invest in a real estate project offering a high rate of return
- Lend the funds to a third-party who will pay high interest
- Invest in a new franchise or enterprise
You can take the money out for any purpose, without restriction – but there are reasons to think twice about doing so, as you will see below.
Are There Any Taxes or Penalties Due for Borrowing from a Solo 401(k)?
Internal Revenue Code Section 72(p) allows Solo 401(k) participants the ability to borrow plan money tax-free and without penalty. However, if you can’t pay the balance within the five-year repayment period, you’ll be taxed on the full amount as if it were a distribution AND, if you’re under 59.5, you’ll be subject to a 10% early withdrawal penalty on top of it.
What Are the Best Alternatives to a 401(k) Loan?
Local banks or credit unions may be able to offer a loan that compares. Since the interest on a 401(k) loan is not tax-deductible, the cost of these alternative options may actually be lower.
If you are looking to open a Solo 401(k) or have any questions about facilitating a loan, contact Ubiquity. We’ve been setting up Solo 401(k) plans since 1999 with the industry’s lowest monthly flat fee.
