Solo 401k Loans Explained: Is It A Good Idea?

Open a solo 401k plan online in under 10 minutes – The Carry Solo 401k Plan is a featured-packed self-directed account that lets you invest in both traditional and alternative assets, take out a loan, or do a mega backdoor Roth conversion with a few clicks.

A solo 401k loan lets you tap into your solo 401k account and borrow money from your own nest egg. Essentially, you’re lending money to yourself, with the requirement to pay it back. It doesn’t sound like a great deal, but it can make a lot of sense in certain cases. Plus, a solo 401k loan gives you access to your funds faster than traditional loans. It doesn’t require any credit checks, and you can use the funds however you want.

However, while the interest rates and repayment terms aren’t terrible, the real damage comes from depleting your retirement account of funds that would otherwise be invested. Here’s everything you need to know about the solo 401k loan.

How much can I borrow?

With a solo 401k loan, you can borrow up to 50% of your account’s value, up to a maximum of $50,000. You cannot get a loan over $50,000 no matter how much you have in your account.

Let’s look at a few examples:

Your plan value is determined by liquid cash

Another thing to note is that your plan value is determined by how much you have in liquid cash in your account. Funds that are invested in assets will not be considered for the loan.

For example, let’s say you have $500,000 in your solo 401k account. $450,000 of it is invested in assets like ETFs, real estate, and individual stocks, and you only have $50,000 sitting in cash. Your account value would be considered as $50,000 and you would be able to get a loan up to 50% of that, which would be $25,000. If you wanted to increase your loan size to the maximum amount of $50,000, you would need to sell assets in your account in order to hold at least $100,000 in cash.

What if I borrowed more than my limit?

Whether it was by accident or not, any amount over the maximum allowed will be treated as an early-distribution. The money will be subject to a 10% penalty fee plus taxes.

For example, let’s say you only had $20,000 in your account. In this case, the maximum amount you can borrow is $10,000 (50%). But let’s say you took out a loan for $15,000, instead. In this case, the extra $5,000 would be subject to a 10% tax ($500) plus income taxes according to your tax bracket for the year.

Can me and my spouse both take out a solo 401k loan?

Yes. In this case, you and your spouse can both tap into your own solo 401k accounts and request a loan. The limits only apply to you individually, so essentially your household can take out two solo 401k loans for a maximum combined total of $100,000.

What are the interest rates?

The interest rate depends on the plan provider. Typically, it’s Prime Rate plus one or two percent. Whether it’s one or two percent is where it depends on the plan provider. The good news is that plan providers can’t just set whatever interest they want. The U.S. Department of Labor (DOL) requires that interest rates are reasonable for a solo 401k loan, and must be reviewed with each loan application. 

When do I have to pay the money back?

With a solo 401k loan, you have five years (60 months) to pay back the money in full. Yes, you’re essentially paying it back to yourself, but those are the rules. The only exception to this is if you’re using the funds from the loan to purchase a primary residence. If that’s the case, you get 15 years to pay it back. Note that this only applies for first-time purchases of a primary residence property. Refinancing will not be eligible.

The repayment schedule is set by your plan provider, but the IRS requires that regular payments of equal amounts must be made at least on a quarterly basis.

How do I qualify for a solo 401k loan?

One of the biggest benefits of a solo 401k loan is that there are no strict eligibility requirements. As long as you have money in your account, you’re eligible. No credit checks are required, and no restrictions on how you use the money. As a result, the process is a lot faster than borrowing money from other financial institutions.

Will I need to have good credit to qualify for a solo 401k loan?

Nope. A solo 401k loan doesn’t require a credit check. Instead, the loan is secured with the remaining 50% of your account balance.

Can I use the money for whatever I want?

Yes. There are no restrictions on how you spend the money from your solo 401k loan. Whether you take the loan out of necessity for unexpected living expenses, or want to make an impulse purchase, how you use the funds is completely up to you.

In other words, the IRS doesn’t care because giving you the loan is beneficial for them. You’re borrowing your own money, securing it with your own funds, and paying them the interest! And if you can’t pay it back on time, they get paid the penalty fees.

Should I take a solo 401k loan?

In most cases, a solo 401k loan is a bad idea. Not only do you pay interest for borrowing your own money, you also lose out on the interest that money would typically earn you (with tax-free compounding) in your retirement account.

However, there are some instances where a solo 401k loan might be a good idea: