The Do’s & Don’ts of Solo 401k Promissory Note Investment

A popular investment made through a self-directed solo 401k is a promissory note investment for a variety of reasons including indirectly investing in real estate without having to take on the additional headaches that come along with investing in real estate. However, just specific rules apply when investing a solo 401k directly in real estate, rules also apply to promissory note investments made under a solo 401k plan.  Following are the do’s and the don’ts for investing a solo 401k in promissory notes.

Video Slides: The Do’s and Don’ts of Promissory Note Solo 401k Investment

The Enhancing Emergency and Retirement Savings Act Would Allow for Penalty-Free “emergency Distribution” option from Solo 401k Plans and Self-Directed IRAs

On June 1, 2021 a proposed bill (The Enhancing Emergency and Retirement Savings Act) was introduced by by Senator James Lankford (R-OK) and Michael Bennet (D-CO). The proposed bill would provide a penalty-free “emergency distribution” option from employer-sponsored retirement accounts (e.g., solo 401k) and IRAs (e.g.., self-directed IRA).

The main purpose of the bill is to encourage more participation in 401k plans including solo 401k plans since generally distributions cannot be made from retirement accounts until the participant meets a triggering event such as age 59 1/2, no longer working for the employer or, in the case of the self-employed, no longer being self-employed.

“So many Oklahomans live paycheck to paycheck. They want to start saving for retirement, but they can’t take the risk of losing access to their money in case of an emergency,” Lankford stated in introducing his legislation. “Our commonsense bill provides Americans the flexibility to save for retirement now, knowing they have access to some of their money for an emergency and be able to pay that money back into their retirement plan.”

“Millions of families are trapped in this cycle of economic insecurity—one emergency away from everything falling apart. This bipartisan legislation will help give workers more flexibility to foot the bill for an unexpected emergency expense,”  Bennet stated, noting that nearly 4 in 10 Americans cannot afford a $400 emergency expense. 

Here are some key items found in the proposed bill:

  • The participant could distribute funds from the solo 401k for a personal emergency without satisfying a typical solo 401k distribution exception
  • Just one emergency distribution would be allowed each year. 
  • The maximum emergency distribution would be $1,000 per participant. 
  • The amount distributed on account of an emergency distribution would need to be returned back to the same solo 401k plan before an additional emergency distribution from that same solo 401k plan is allowed.

Good News: Impact of Biden’s Plan on Self-Directed Solo 401k

On May 28, 2021 President Biden released his first budget proposal under his presidency. The $6 trillion plan includes two proposals: American Jobs Plan, which addresses infrastructure, and the American Families Plan, which covers child care, paid family and medical leave.

As far as retirement plans including self-directed IRAs and the self-directed solo 401k plans, the budget proposal does not include any changes at this time. This is welcomed news considering Biden had campaigned to impose a financial transaction tax on equity investments made under retirement accounts which includes IRAs and 401k plans.

On another note, the self-directed solo 401k may become more popular considering the budge proposal calls to increase the corporate tax rate to 28% from 21%. Since the solo 401k plan allows for pretax contributions, this may be a good way to reduce paying higher corporate taxes.

Further, the budget proposal also seeks to increase the top marginal individual tax rate to 39.6%. Therefore, sole proprietor businesses may also benefit from setting up a solo 401k plan and making pretax contributions to reduce their taxable earned income.