One of the main reasons why the self-employed open a solo 401k plan is to be able to borrow/take a loan from the solo 401k plan. Therefore, it is important to understand how solo 401k participant loans are calculated. If a solo 401k loan exceeds the statutory limit, the loan will be deemed a distribution and will be taxable to the participant (who will also be subject to a 10 percent early distribution penalty if under age 59½).
As long as the solo 401k participant loan satisfies the rules found in IRC Sec. 72(p)(2), which lists the amount that may be borrowed and details the payment requirements, the loan will not be considered a taxable distribution.
Under the solo 401k loan policy, the solo 401k participant may generally receive a loan of up to 50 percent of her vested account balances, up to a maximum loan amount of $50,000. The maximum loan amount is calculated differently, however, if a participant already has an outstanding solo 401k plan loan.
ILLUSTRATION: No Outstanding Solo 401k Loan Balance
Ben would like to take a loan from his solo 401k plan, which allows for loans of 50% of his solo 401k account balance, up to$50,000. Because Ben has a balance of $60,000, the maximum amount that he can borrow from the account is $30,000 (50% x $60,000). If Ben had a solo 401k balance greater than $100,000, his solo 401k participant loan would be capped at $50,000 regardless of the 50% calculation.
Maximum Limit for Multiple Solo 401k Loans
Provided certain rules are satisfied, the solo 401k participant may have more than one outstanding solo 401k loan from the plan at a time. But any new loan, when added to the solo 401k participant’s outstanding loan balance, cannot exceed the lesser of a) 50 percent of the participant’s vested balance, or b) $50,000 reduced by the difference between
- the highest outstanding solo 401k loan balance from the plan at any time during the one-year period ending on the day before the new loan is made, and
- the outstanding loan balance on the date the new loan is made.
ILLUSTRATION: Multiple Solo 401k Loans When Solo 401k Balance is Over $100,000
On January 1, 2016, Beth had a solo 401k plan balance of $125,000 and processed a solo 401k loan amount of $40,000 to be paid in 20 quarterly installments. On January 1, 2017, the outstanding loan balance is $33,322, and Beth decides that she wants to take a second solo 401k loan.
Beth’s second solo 401k loan plus her current outstanding solo 401k loan balance cannot exceed $50,000 reduced by the difference between the highest outstanding loan balance for the preceding one-year period ($40,000) and the outstanding loan balance on the day the new loan is to be made ($33,322).
Step 1: Highest outstanding balance – current outstanding balance = the difference
$40,000 – $33,322 = $6,678
Step 2: $50,000 – the difference = maximum outstanding loan amount
$50,000 – $6,678 = $43,322
Step 3: Maximum outstanding loan amount – current outstanding balance = maximum second loan amount$43,322 – $33,322 = $10,000
The maximum amount Beth can take for her second solo 401k participant loan, therefore, is $10,000.
ILLUSTRATION: Multiple Solo 401k Loans When Solo 401k Balance is Under $100,000
Tim processed a solo 401k loan from his solo 401k plan in 2016. One year later, Tim needs more money so he decides to borrow a second time from his solo 401k. Tim’s highest outstanding loan balance is $32,500, his current outstanding loan balance is $29,000, and his current vested account balance is $75,000. Bill’s new solo 401k loan plus his outstanding loan balance cannot exceed 50 percent of his solo 401k account balance.
Step 1: 50% x $75,000 = $37,500
Step 2: $37,500 – current outstanding loan balance = maximum second loan amount
$37,500 – $29,000 = $8,500
The maximum additional solo 401k loan amount Tim may borrow from the solo 401k plan is $8,500.
To visit the IRS page that deals with the multiple solo 401k loan rules, CLICK HERE.
To learn more about the various loan rules including what happens when the solo 401k loan goes into default, VISIT HERE.