Solo 401k Loan: Borrow Up to $50,000 to Pay Off 25% APR Card Debt
Solo 401k loan webinar: How to Pay Off Credit Card Debt With a Solo 401k Loan, a live session by My Solo 401k Financial, recorded .
Key Takeaways: Solo 401k Loan for Credit Card Debt
- A Solo 401k loan is limited to the lesser of 50% of the account balance or $50,000.
- A $30,000 credit card balance at 25% APR costs $7,500 a year in interest, or $625 a month, according to the webinar.
- A Solo 401k loan used to pay off credit card debt must be amortized over 60 months with monthly or quarterly payments.
- An unpaid Solo 401k loan balance becomes a deemed distribution, taxed as ordinary income plus a 10% penalty if the borrower is under age 59½.
- Discount brokerage Solo 401k plans at Fidelity and Schwab do not allow loans, while plan documents from My Solo 401k Financial do, and loan documents are prepared within one business day.
- The 12-month look-back rule reduces a new Solo 401k loan by the highest outstanding balance of any loan during the prior 12 months.
Can I use a Solo 401k loan to pay off credit card debt?
Yes. A Solo 401k loan can pay off credit card debt when the Solo 401k plan document permits participant loans, and the sections below cover the limits, rate, term, and risks.
How does a Solo 401k loan pay off credit card debt?
A Solo 401k loan replaces high-interest credit card debt with a loan from the borrower’s own retirement plan. The borrower takes cash from the plan, pays off the cards, and repays the plan with interest.
What does $30,000 of credit card debt at 25% APR cost each year?
Credit card debt of $30,000 at 25% APR costs $7,500 a year in interest. That works out to $625 every month. The interest payments themselves reduce no principal, and every dollar is a sunk cost paid to the bank.
“$30,000 at 25% APR. That would have an annual interest cost of $7,500. $625 every single month handed to the bank.”
(2:00 in the webinar)
How does a Solo 401k loan let you become your own bank?
A Solo 401k loan works in three moves. The borrower first takes cash from the plan. The borrower then pays the credit cards down to zero, assuming the payoff amount is no more than the eligible loan amount. Finally, the borrower repays the plan in equal payments of principal and interest.
The interest rate on the Solo 401k loan is prime plus 1%, not the 25% card rate. That interest flows into the borrower’s own Solo 401k account.
“Here the interest is not 25%, instead it’s prime plus 1%, which currently as of the date of this webinar would be 8%. But that’s not going to a bank … It’s going into your own retirement account.”
(4:47 in the webinar)
Who is eligible for a Solo 401k loan?
A Solo 401k loan requires a Solo 401k plan, and a Solo 401k plan requires self-employment. The solopreneur can have no full-time W-2 employees other than owners and their spouses. The plan document must also permit loans.
Summary: On a $30,000 balance, credit card debt at 25% APR sends $7,500 a year in interest to a bank. A Solo 401k loan at prime plus 1% pays the interest into the borrower’s own Solo 401k account.
What are the Solo 401k loan limits and rules?
The Solo 401k loan is limited to 50% of the account balance, not to exceed $50,000.
“Number one, the loan is limited to 50% of your balance, not to exceed $50,000 … So you can look across your whole Solo 401k account value. So adding the pre-tax plus the Roth, for example, you take that amount 50% of it.”
(5:32 in the webinar)
Can a Solo 401k loan come from Roth and pre-tax money?
A Solo 401k loan can come from the pre-tax account, the Roth account, or both. Borrowing from both requires two separate loans. Together, the two Solo 401k loans cannot exceed the lesser of 50% of the total balance or $50,000.
How long is the repayment term for a Solo 401k loan?
A Solo 401k loan used to pay off credit card debt has a five-year term. The loan must be amortized over 60 months, with monthly or quarterly payments. The payments must be made at least quarterly.
What interest rate applies to a Solo 401k loan?
The Solo 401k loan rate is prime plus 1%, or a CD rate plus 2%. The CD option uses a comparable CD. A $30,000 loan with a five-year term, for example, would use a $30,000 CD rate plus 2%.
The interest does not go to a bank, to My Solo 401k Financial, or to the plan provider. The interest goes into the borrower’s own Solo 401k account.
Which Solo 401k plans allow a loan?
A Solo 401k loan is available only when the underlying plan document allows participant loans. Plan documents at discount brokerages such as Fidelity and Schwab do not allow loans. A participant can still keep the account at Fidelity or Schwab.
Summary: Discount brokerage Solo 401k plan documents do not allow loans. Solo 401k plan documents from My Solo 401k Financial allow a Solo 401k loan and stay portable to Fidelity, Schwab, or another institution.
My Solo 401k Financial does not hold or have access to customer accounts. The plan is portable, so a customer obtains the plan documents and then opens an account at the institution of choice.
How do you take a Solo 401k loan in five steps?
Taking a Solo 401k loan follows five steps, as outlined in the webinar.
- Check your plan. The Solo 401k plan documents must allow a 401k participant loan.
- Verify the limits. The Solo 401k loan is limited to 50% of the balance, not to exceed $50,000.
- Set your rate. Use prime plus 1%, or a comparable CD rate plus 2%.
- Sign the note. My Solo 401k Financial prepares loan documents within one business day.
- Disburse the cash and pay off the card. Wipe out the credit card debt, then start repaying yourself instead of the bank.
My Solo 401k Financial prepares the required Solo 401k loan documents at no additional charge for customers. The customer submits a form on the website. The questionnaire asks how much to borrow and whether payments will be monthly or quarterly.
What are the risks of a Solo 401k loan?
What happens if a Solo 401k loan goes into default?
A defaulted Solo 401k loan does not go on a credit report, unlike defaulted credit card debt. The consequence is tax instead. The unpaid balance is treated as a deemed distribution.
“Default does become a taxable event … the unpaid balance would trigger ordinary income tax plus a 10% penalty if you’re under age 59 and a half.”
(9:43 in the webinar)
What is the investment opportunity cost of a Solo 401k loan?
A Solo 401k loan removes dollars from the plan that could otherwise be invested in stocks, bonds, or alternative investments. The borrower who repays the loan recoups the money plus interest. The Solo 401k account will still grow accordingly.
Does a Solo 401k loan require steady cash flow?
A Solo 401k loan requires steady cash flow. Repayments are due regardless of what happens in the business or on the borrower’s personal balance sheet, and regardless of what the borrower used the money for.
Which compliance mistakes make a Solo 401k loan costly?
A Solo 401k loan needs a written note. A loan with no documents is a compliance mistake, which is why My Solo 401k Financial prepares the loan documents for customers.
Missed repayments are the second mistake. A Solo 401k loan has a grace period for missed payments, after which the loan defaults.
“You have until the end of the quarter following the quarter when you miss the payment or payments to make up all the payments from the prior quarter. But if you’re not able to do that, then the loan will go into default.”
(11:08 in the webinar)
Exceeding the caps is the third mistake. A Solo 401k loan cannot exceed 50% of the balance or $50,000, whichever is less.
How does the 12-month look-back rule affect a second Solo 401k loan?
The 12-month look-back rule applies when a borrower takes more than one Solo 401k loan. The borrower checks whether any Solo 401k loan was outstanding during the prior 12 months.
“You have to reduce how much you can take as that subsequent loan by the highest outstanding balance of any loan over the prior 12 months. Even if … at the time of the subsequent loan, you had already paid back that prior loan.”
(12:39 in the webinar)
Can a Solo 401k loan be used for home improvement or other purposes?
A Solo 401k loan can be used for any purpose whatsoever, including home improvement. An attendee asked about home improvement live.
“Beyond credit cards, can we borrow for home improvement work? Yes, you can. You can really use the money for any purpose whatsoever.”
(15:04 in the webinar)
A Solo 401k loan for home improvement still has a five-year term. Only a loan used to purchase a primary residence can extend beyond five years.
Solo 401k Loan FAQ
Can I use a Solo 401k loan to pay off credit card debt?
Yes. A Solo 401k loan can pay off credit card debt if the Solo 401k plan document permits participant loans. The borrower takes cash from the plan, zeroes out the cards, and repays the plan in equal payments of principal and interest, so the interest goes into the borrower’s own retirement account.
How much can I borrow with a Solo 401k loan?
A Solo 401k loan is limited to the lesser of 50% of the account balance or $50,000. The balance is measured across the whole Solo 401k account, adding pre-tax and Roth money together. A participant with a $100,000 balance can borrow up to $50,000, and a participant with $60,000 can borrow up to $30,000.
What interest rate does a Solo 401k loan charge?
The webinar described the Solo 401k loan rate as prime plus 1%, or a comparable CD rate plus 2%. The interest is not paid to a bank or to the plan provider. It is deposited into the borrower’s own Solo 401k account.
How long do I have to repay a Solo 401k loan used for credit cards?
A Solo 401k loan used to pay off credit card debt has a five-year term and must be amortized over 60 months. Payments can be monthly or quarterly, and the borrower chooses the schedule. Only a loan used to purchase a primary residence can extend beyond five years.
What happens if I default on a Solo 401k loan?
A defaulted Solo 401k loan does not appear on a credit report, but the unpaid balance becomes a taxable deemed distribution. The unpaid balance triggers ordinary income tax, plus a 10% penalty if the borrower is under age 59½. A missed payment can be cured until the end of the following quarter.
Can I take a Solo 401k loan from my Roth and pre-tax accounts?
Yes. A Solo 401k loan can come from the pre-tax account, the Roth account, or both. Borrowing from both accounts requires two separate loans. The combined amount of the two loans cannot exceed the lesser of 50% of the total balance or $50,000.
Does a Fidelity or Schwab Solo 401k allow loans?
No. The Solo 401k plan documents offered directly by discount brokerages such as Fidelity and Schwab do not allow loans. A participant can still hold the account at Fidelity or Schwab while using Solo 401k plan documents from My Solo 401k Financial, which do allow a Solo 401k loan.
Can I take a second Solo 401k loan after repaying the first?
Yes, but the 12-month look-back rule applies. A new Solo 401k loan must be reduced by the highest outstanding balance of any loan during the prior 12 months, even if that earlier loan is already repaid. The $50,000 and 50% caps still apply to the new loan.
This article is based on the live webinar hosted by My Solo 401k Financial.
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