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Solo 401k Loan: Can I use a Solo 401k loan to Buy a Business?
Thinking of tapping your retirement funds to purchase a business? A solo 401k loan allows you to borrow up to $50,000 (or 50% of your account balance, whichever is less) towards this goal. But there are caveats to consider before taking the plunge. Here’s what you need to know.
Benefits
- Access up to $50k towards a down payment
- Access funds quickly without undergoing credit checks or qualifications
- Pay back yourself (i.e. your retirement account) instead of a bank or other finance company
Drawbacks
- If the business fails, you still need to repay the loan as per the original schedule.
- The Solo 401k loan has no contingencies based on business performance.
The Rules
- Solo 401k Loans need to be repaid in 5 years, with interest (i.e. prime plus 1% or a CD rate plus 2%).
- Payments must be made on a monthly or quarterly basis.
- If employment circumstances change (e.g. hiring a full-time W2 employee), the 401k may need to be terminated and loan repaid immediately.
Example Scenario
John is a self-employed CPA and has a solo 401k with a balance of $100,000. He takes a $50,000 loan from the 401k to put towards buying a franchise location of a tax service business with no non-owner full-time w-2 employees. Though the business ends up not being as profitable as quickly as John expected, he needs to continue making payments on the solo 401k loan per the original 5-year repayment schedule.
FAQs
Q: Can I take a solo 401k loan to buy my own small business as a side gig? A: Yes, as long as you have no full-time W2 employees working for any business owned by you (or a spouse if any) and continue operating it as a sole proprietorship.
Q: What if I can’t repay the loan and go into default? A: The outstanding loan balance will be treated as a distribution, subject to income tax plus a 10% early withdrawal penalty if under age 59 1⁄2.
Q: Can I take multiple loans from my solo 401k?
A: Yes, but the highest outstanding balance of all your 401k loans (including looking back over the prior 12 months under the multiple loan rules) cannot exceed $50k or 50% of your account balance, whichever is less.
By understanding the unique benefits, drawbacks, and regulations surrounding solo 401k business loans, you can make the most informed decision possible.
