Borrowing From Your Solo 401(k)
By Steve Sheppherd
Another real advantage of the Solo 401(k) over an IRA is the ability to borrow money from your 401(k) personally. Not an investment, obviously you can do that.
You are Trustee of the plan. If you need money personally–maybe you want to fix up a house or you need a little money to help with your child’s education–you don’t have to worry with the Solo 401(k). You can borrow, according to the law, up to half of your 401(k), to a maximum of $50,000 for up to 5 years. So if you have $40,000 in the account, you can borrow $20,000. If you have a $100,000, you can borrow $50,000. If you have $200,000 you can still only borrow $50,000.
Keep in mind that, if you and your spouse are both participants of the 401(k) plan, each spouse can borrow up to $50,000 of their 401(k) funds. So theoretically, a husband and wife could borrow a total of $100,000 out of the plan.
Sometimes, this is a great way to make money for your retirement if you have some really high credit card bills, for example. Why not pay interest to your own 401(k) plan, instead of to a credit card company.
As a final note, the one exception to the 5 year term for the loan, is if you are using the loaned funds to pay for your primary residence. If all of the loaned funds are used to purchase or pay down the debt on your primary residence, the loan term can be up to 15 years.
How is the loan interest decided? Is the interest rate set by the IRS? Or do you just decide? Or perhaps no interest at all? Thank you.
Participant loans from a 401(k) are governed by 26 USC 72(p)(2) and 29 CFR 2550.408b-1 and require that the loan bear a “reasonable rate of interest”. Here’s a direct quote from CFR 2550.408b-1(e):
(e)Reasonable rate of interest. A loan will be considered to bear a reasonable rate of interest if such loan provides the plan with a return commensurate with the interest rates charged by persons in the business of lending money for loans which would be made under similar circumstances.
A reasonable rate of interest has generally been recognized by the IRS as being the prime rate plus 1%. Interest does have to be charged on the loan, or else the loan is disqualified, and the loaned amount would be treated as a distribution.
Let us know if you have any other questions.