Each Solo 401k by Nabers Group automatically includes a participant loan, where you can take a personal line of credit of up to $50,000.
What is a Participant Loan?
A Solo 401(k) participant can borrow up to either $50,000 or 50% of their account value with the following terms:
- To be repaid over an amortization schedule of 5 years or less
- Regular payments no less frequently than quarterly
- At a reasonable rate of interest… generally interpreted as prime rate + 1%
Under what conditions is the participant loan allowed?
Any. As long as the plan documents allow for it & the proper loan documents are prepared and executed, a participant loan can be made for any reason.
Why Would You Want a Participant Loan?
This can be useful when someone is thinking about distributing money out of their Solo 401k plan for some reason. We recently spoke with a a man who was going to distribute his $100k IRA to pay for finishing the repairs of 2 fixer upper houses. After we spoke, his strategy was amended to instead:
- Setup a Solo 401k plan (adopted by his business) and transfer IRA funds into it
- Take a participant loan of $50k
- Use the loan proceeds to finish rehabbing Property #1 (which was owned personally free & clear)
- Do a cash out refinance on Property #1 once rehab is complete
- Use refi proceeds to finish rehabbing Property #2 & pay back the Solo 401k participant loan
In his situation, it made sense to pull some equity out of Property #1 to pay for the completion of Property #2 (and the early repayment of the participant loan) because the rental income (upon completion) of Property #1 covered about 350% of its new loan payments.
The result of the new strategy
- Avoided IRA distribution
- Avoided $35,000 in distribution taxes
- Paid participant loan back within a few months
- The rental income of Property #1 will payoff its mortgage within 6 years (with maximum principal reduction payments)
- Left $100k in his retirement account for maximum tax deferred growth
There are many other common uses for a Solo 401k participant loan. If a person wants to make a <$50k investment that would otherwise be a prohibited transaction, they can just borrow the money and do the investment as an individual.
Additionally, the Participant Loan is a compliant way to get cash from the Solo 401k to infuse into your business.
When Do I Have to Pay the Loan Back?
The standard limit for a participant loan repayment period is five years or 60 months.
The exception to the rule is for using the loan to purchase a primary residence (real estate), in which the repayment period can extend up to 15 years. In order to qualify for the extended repayment period, the loan must be designated as going towards the purchase of a primary residence property.
Please note that the extended repayment period is not applicable for refinancing and may be made toward new purchases only.
What’s the Procedure for Taking a Participant Loan?
Taking a participant loan from your 401k is very easy. There are no separate reporting requirements for the loan. All you need to initiate the loan is the proper loan documents.
We can prepare your loan documents at any time after you have set up your Solo 401k plan with Nabers Group.
To have our team prepare your loan documents, simply do the following:
- Email [email protected] with:
- Your desired loan amount (the lesser of $50,000 or 50% of your vested account balance) and;
- Desired loan term (up to 5 years)
Then, our team can prepare the participant loan documents for your signature. Once the loan documents are signed, you can wire funds from your 401k bank/brokerage account to your personal (not business) checking account.
You should also keep a record of your loan payments back to the plan. This keeps everything in line and documented.
How Much Money Can I Get?
Your loan amount is the lesser of $50,000 or 50% of your vested account value:
- Example: If you have $40,000 in your Solo 401k, your maximum loan amount is $20,000
- Example: If you have $500,000 in your Solo 401k, your maximum loan amount is $50,000
The account value is your vested account balance, and doesn’t require all funds to be liquid. Therefore, if you have $100,000 invested in real estate and $60,000 liquid – as long as those funds are fully vested, you can take out the maximum $50,000.
You are able to invest the rest of the cash not included in the loan. For example, if you have $100,000 cash in the Solo 401k, you can take a loan of up to $50,000. You are then able to invest the remaining $50,000, even after you have taken out the first $50,000 in the loan to yourself as the participant.
You and your spouse can each take a participant loan from the Solo 401k. The amount you and your spouse can each take out in a loan is directly related to the amounts each of you have rolled in and/or contributed to the Solo 401k.
- Example: If you rolled in $80,000 you can take a loan of $40,000. If your spouse rolled in $200,000, they can take a loan of up to $50,000
Who Determines the Interest Rate?
The interest rate on a participant loan is fixed at the prime rate plus 1%.
Who Writes the Check?
You’ll write a check from your Solo 401k trust bank account to you as the participant. You cannot make the loan check out to anyone else (your business, your friend, etc).
Loan repayments should be made by you (the participant) directly back into your 401k bank or brokerage account (wherever you have the depository account for your 401k trust funds)
What Happens if I Don’t Pay the Loan Back?
In the event you defaults on three payments of any part of the principal of interest that may become due on the loan, or if you declare bankruptcy, the entire unpaid principal plus accrued interest thereon become due and payable immediately. In addition, the Plan’s Trustee(s) may take such measures as are necessary in order to execute on the collateral that the Participant has pledged as security. In cases of a default, the loan amount outstanding is considered a premature 401k distribution on which you will owe income tax plus a 10% penalty if you are younger than 59 1/2.