Case Study: Solo 401k for Small Business Financing

When Andrew and Jenna came to Nabers Group, they were trying to launch their real estate wholesaling business. They had some money saved, but not enough to do their first deal. They needed to find a source of small business financing to get their business off the ground.

Banker Bureaucracy and Non-Compliant Plans

First they went to the bank to see if they could get a small business loan. Of course the bankers asked for every piece of paperwork you could imagine. The banker wanted income stubs, credit checks, business plans and the like. The first bank turned them down. The second bank approved them. Unfortunately, the interest rate was astronomical and they decided it would ultimately be a bad deal for their business.

Andrew and Jenna have IRA and 401k plans just sitting in mutual funds and money market accounts. So, they looked into a ROBS plan. ROBS was touted as a way to get small business directly from your retirement funds. However, they ultimately decided against that route because it was expensive, complicated, and a gray area of compliance with the IRS. The risk just seemed to great to put their retirement funds at risk so they set about looking for other options.

As a last resort, they tried to raise funds from friends and family. But while Andrew & Jenna were confident they would be successful, it was just too big a gamble for their loved ones.

DIY Small Business Financing

After doing some research, Andrew and Jenna decided they wanted a Solo 401k plan. They learned there was a way to legally tap into their 401k funds tax-free. Plus, they could also use the retirement account to buy real estate, since they already have experience in the field.

Andrew and Jenna set up their Solo 401k plan and rolled over their funds. Andrew had about $250,000 from previous employer 401ks, and traditional IRA plans. Jenna had about $100,000 from a few different IRAs and a 403b. They rolled in a total of $350,000 into their Solo 401k plan.

They then took a participant loan as a source of their own small business financing.

The participant loan is an IRS compliant strategy to get a tax-free loan from your own retirement funds. The process is simple and immediate. There is no banker underwriting you or your business. You simply get to take a tax-free loan from your retirement account and pay yourself back. The funds from the loan can be used for anything, including small business financing for your business.

Loan Parameters

With Solo 401k small business financing, you can take a tax-free loan of up to 50% of your retirement funds. The maximum loan amount you can take is $50,000. If your spouse works in your business with you, your spouse can take a loan, too. This means you can take a tax-free loan from your retirement money of up to $100,000.

Andrew rolled $250k into the Solo 401k, so he was able to take the full loan amount of $50,000. Jenna rolled in $100k, so she took the full $50k loan, too. Now they had $100k in DIY small business financing to put toward their first wholesaling deal.

The loan needs to be paid back to the Solo 401k plan within five years. Fortunately, Andrew & Jenna set up monthly payments into their Solo 401k bank account to ensure loan payments happened on time. There is interest on the loan, but the Solo 401k is who earns the interest. This means that Andrew and Jenna can pay their 401k back instead of sending the interest payments to a banker.

Moving Forward

Andrew and Jenna scraped enough cash together from their savings and the loan from their 401k to do their first deal. They sold at a profit and had enough to get a second deal. They were able to stay on top of their 401k loan repayments and paid off the loan in just 3 years.

Things were going well in the business, so they decided to take another 401k loan as small business financing to get some more deals. The business was slowly growing, and they were gaining traction. They paid back their second loan in 2 years and had been steadily growing their nest egg.

All the while, they were even able to start purchasing properties with the remaining funds in the Solo 401k. This allowed Andrew and Jenna to leverage their real estate experience in their wholesaling business into their retirement account investments. They stuck with passive buy & hold deals inside the 401k and focused on wholesaling in their business.