Can you borrow from a Solo 401(k)? The rules on taking out loans

Not only does a Solo 401(k) plan allow you to set aside money for the future, but you can also borrow from your plan account at any time to get fast access to capital.

For an entrepreneur, this quick access to cash (we’ll discuss how much and repayment terms later) can be a lifeline. Even better, there are no restrictions on what this loan can be used for, whether it’s to further your business or for personal use. 

There’s a lot to unpack when it comes to borrowing from your Solo 401(k) though, so let’s walk through it.

Can you take a loan from a Solo 401k?

If your Solo 401(k) plan document allows for it, then you absolutely can borrow from your Solo 401(k).

This is one of the benefits of a self-directed plan, since you are in control of the plan you can borrow at any time without restriction (within the borrowing limits and repayment terms, more on that later).

It’s important to know that there are strict repayment rules for these loans. Typically, you must repay the loan within five years, with payments usually required at least quarterly and including both principal and interest. Failing to follow these rules can result in the loan being deemed a distribution, which may have tax and penalty implications.

What you need to know before borrowing from your Solo 401(k)

Before pulling the trigger on that loan, there are a few things you need to be aware of.

If your plan is self-directed, remember that you administer the loan

The nice benefit of a self-directed Solo 401(k) is that you are in complete control of the plan, as opposed to a plan that is not self-directed. That means that you do not need to get approval before taking the loan, you just need to request it from your account and repay it over time. 

Remember though, because your plan is self-directed then you are responsible for managing the plan documentation, records, and loan repayment. The SEPira(k) platform makes requesting a loan from your Solo 401(k) plan easy with our loan and repayment features.

How much can you borrow from a Solo 401(k)?

Solo 401(k) loans are a fantastic way for self-employed individuals to access capital quickly, but they are not an unlimited resource.

The maximum loan amount is the lesser of $50,000 or 50% of your vested account balance. With the SEPIRAk platform, you can only take one loan at a time. 

How to repay a Solo 401(k) loan

Once you have the funds transferred to your personal account, you need to have a plan to repay your loan on time.

Repayments are made over a maximum term of five years unless the loan is used to purchase your primary residence, which might allow for a longer repayment period. Remember that you will need to pay interest as well as the principal.

These repayments are made back into your Solo 401(k) account, which means you're paying interest to yourself. This makes a Solo 401(k) loan very favorable compared to other types of loans where you lose money on the interest payments. However, keep in mind that these repayments are made with post-tax dollars, which creates a potential double-taxation scenario when the money is ultimately distributed in retirement.

What is the interest on a Solo 401(k) loan?

The interest rate for a Solo 401(k) loan is determined based on the rules set in the plan document. 

Typically, the interest rate is considered to be reasonable and is often benchmarked against an index like the Prime Rate. The Prime Rate is the interest rate that banks charge their most creditworthy customers, and it's often used as a benchmark for many types of loans, including Solo 401(k) loans.

The actual rate for a Solo 401(k) loan is often set at the Prime Rate plus a small percentage, for instance, Prime Rate plus 1 or 2 percent. This rate is usually fixed for the life of the loan. This means once you take out the loan, your interest rate will remain the same until the loan is fully repaid.

Remember, since the plan is self-directed then that the interest you're paying on the loan is actually going back into your Solo 401(k) account. In other words, you're paying the interest to yourself, not to a bank or other lender. It’s important to note though that the repayments (including the interest) are made with after-tax dollars, and the interest will be taxed again when you withdraw it in retirement, creating a potential double-taxation scenario. 

What if I don’t repay in time?

If the loan is not repaid according to the agreed terms, it is considered a distribution. 

This means the outstanding loan balance becomes taxable and, if you're under the age of 59.5, an additional 10% early withdrawal penalty may apply. As a result, it's critical to fully understand your repayment obligations and consider the potential implications of not meeting them before taking a loan from your Solo 401(k) plan. 

Why a Solo 401(k) loan can be useful

The good news is that there are no specific restrictions on how you can use the funds from a Solo 401(k) loan. You can use them as you see fit, and here are five potentially beneficial uses:

• Consolidate debt: If you have high-interest debt like credit card balances or personal loans, using a Solo 401(k) loan to consolidate and pay down that debt can be a smart move. The interest rate on a Solo 401(k) loan is often lower than those on credit cards or personal loans, potentially saving you money in interest over time.

• Home Improvements: Whether it's necessary repairs, energy-efficient upgrades, or a kitchen remodel, home improvements can be a valuable investment. By using a Solo 401(k) loan, you can finance these improvements without incurring high-interest debt.

• Education or student loans: Whether it's for you or a family member, a Solo 401(k) loan can be used to fund education expenses. It could cover tuition, books, living expenses, or even pay off student loans.

• Business Investment: As a small business owner or self-employed individual, there may be times when you need to invest in your business to facilitate growth. A Solo 401(k) loan could provide the necessary capital to purchase equipment, expand your product line, or even hire additional help.

• Emergency Expenses: Life is unpredictable, and unexpected expenses can pop up at any time. Having the option to take a loan from your Solo 401(k) plan can be a financial lifeline in case of medical emergencies, major home repairs, or sudden loss of income.
  

The life of a self-employed individual can be unpredictable. Given the favorable terms of a Solo 401(k) loan, it can be a great way to access capital quickly and pay it back over time.

How to take a loan from your solo 401k

You are probably getting the hang of it, but if you’re still unclear on the details here is a simple 4-step process to borrowing from your Solo 401(k).

Step 1: Does your plan allow for a loan?

Many Solo 401(k) providers allow for loans, but not all. If you have a plan with SEPira(k) then you automatically get access to all of our loan and repayment features.

Step 2: Determine how much you can borrow

Your next step is to determine how much you can borrow. Remember, the maximum loan amount from a Solo 401(k) is typically the lesser of $50,000 or 50% of your vested account balance. Again, the SEPira(k) platform makes this easy as our loan interface will guide you through how much you are allowed to borrow.

Step 3: Submit a loan application and access your funds

With the loan amount figured out, you'll then need to complete a loan application. You can submit an application through SEPira(k), and since you also play the role of Plan Administrator you are in charge of approving your loan.  Once approved, you will get access to your funds and you can use them as you wish.

Step 4: Repay your loan

Once the loan is disbursed, you will need to start making regular payments, often quarterly. These payments will include both the principal and interest. It's crucial to make these payments on time, as failure to do so could result in the loan being considered a distribution, with potential tax consequences and penalties.

Ready to reap the benefits of a Solo 401(k) plan? Create an account with SEPira(k) and start saving today.