The Solo 401k loan is a very important benefit of a solopreneur’s retirement plan. IRAs (even SEP IRAs) do not permit loans! It’s important to follow the rules if you ever need to use this benefit. In this post, we will explore the specific benefits, pitfalls, and rules of the Solo 401k loan. By the end of this post you will know exactly how to use a Solo 401k loan.
A Solo 401k loan is exactly what is sounds like. You loan a portion of your balance from your tax-advantaged Solo 401k plan to yourself, personally. Then, you pay back the loan with interest to your 401k plan; basically you are paying back your future self. The loan provisions are custom-tailored to suit your needs. Overall, it is a very flexible arrangement.
The loan is not a free-for-all. You must follow some rules to keep your loan in compliance.
A few years ago one of my clients was about to close a real estate deal, but fell short on funds to complete it. Fortunately, she had a Solo 401k from which she took a loan of $50,000. The origination process was quick and she closed her deal successfully because she didn’t need approval from a third party. The terms of the loan were very favorable to her. She created a loan agreement that provided for the Prime Rate as published in the Wall Street Journal (3.25% at the time) paid back over five years. The payments could be made quarterly, and if she was late she gave herself until the end of the quarter to rectify the default. She saved her real estate deal (which turned out to be a success) and paid off her Solo 401k loan in just 18 months.
Now, I do not recommend opening up a Solo 401k with the intent of using it as a loan facility; however, if you ever need short-term funding a Solo 401k loan is hard to beat.