A Solo 401(k)-also known as a one-participant 401(k) or self-directed 401(k)-is designed for a business owner without employees, but shares many of the benefits and rules as a standard 401(k).

However, one benefit that exceeds traditional employee plans is the ability to take a loan from your Solo 401(k) to finance an investment or even a new home (term lengths differ for primary residences).

With advantageous interest rates and no credit checks, taking a loan from a Solo 401(k) may be one compelling reason to open one, especially if you are looking for additional financing for your business.

This guide will tell you everything you need to know about borrowing from a Solo 401(k) plan.

Quick Takeaways

  • You can take a loan from your Solo 401(k) as long as your plan provider allows it.
  • Solo 401(k) loans are often easier and cheaper to obtain than traditional loans, as you won’t need to undergo a credit check.
  • The amount you can borrow depends on the vested portion of your 401(k) balance, but typically, you can borrow up to 50% of your vested balance up to $50,000 (e.g., if you have $100,000 invested, you can borrow up to $50,000 total).
  • Solo 401(k) loans generally must be repaid in 5 years, though loan terms are longer if you are purchasing a primary residence.
  • If you don’t meet the repayment terms of your Solo 401(k) loan, you may face tax consequences and penalties.

When you invest in tax liens, earnings come from the interest applied to the lien


Can You Take a Loan from Your Solo 401(k)?

Yes, in most cases, you can borrow against your Solo 401(k). The IRS sets the same rules for Solo 401(k) s as they do for traditional 401(k) s and other qualified retirement plans. While the option to borrow against Solo 401(k) plans is common, the plan provider is not required to allow loans, so always check with your provider for specific details.

How Much Can You Borrow from a Solo 401(k)?

Generally, you can borrow up to the greater of $10,000 or 50% of the vested amount in your account with a maximum loan of $50,000, according to the most current IRS guidance.

For instance, if you have $100,0000 or more vested in your account, you can borrow $50,000.  However, if you have $30,000 vested in your Solo 401(k) account, you could only borrow $15,000.

In addition to IRS borrowing limits, your plan provider can set their own limits, which may be lower than those set by the IRS. If you’re considering a Solo 401(k) loan, speak to your provider for plan-specific guidance.

Solo 401(k) Loan Terms

Loans from Solo 401(k) plans include the following terms:

  • Length: Solo 401(k) loans typically must be repaid in 5 years. The term length may be extended if the loan is being used to purchase a primary residence.
  • Interest Rate: 401(k) loan interest rates are based on the current prime interest rate and are generally 1% to 2% higher. For instance, if the prime rate is 8.25%, a Solo 401(k) loan may have an interest rate between 9.25% and 10.25%.
  • Repayment:  You usually must make at least quarterly payments on your loan, though your plan provider may set a specific repayment schedule. You can also repay your loan early without penalty.

Solo 401(k) Loan Penalties and Taxes

If you pay Solo 401(k) loans back according to the terms, you won’t have to worry about penalties or taxes. But if you fail to do so, you can face both.

If you default on your loan, the IRS considers the unpaid balance a distribution. The consequence of that depends on your age and account type but can include:

  • Traditional 401(k) loans that default are subject to income tax based on your current tax bracket, and the loan balance will also incur a 10% early withdrawal penalty if you’re under 59 ½.
  • Roth 401(k) loans that default are also subject to a 10% penalty, as the remaining balance is considered an unqualified withdrawal. However, unlike traditional 401(k) withdrawals, if your account is at least five years old and you’re under 59 ½, only the earnings portion of the loan balance is taxed.

Benefits of a Solo 401(k) Over a Traditional Loan

There are inherent risks of borrowing from your retirement account, but when compared to a traditional loan, there are some benefits worth considering:

  • Potentially lower interest rates: You can often borrow funds from your 401(k) at a lower interest rate than those that apply to traditional loans, especially if you have fair to poor credit.
  • No credit check.  Unlike the traditional loan underwriting process, 401(k) loans don’t depend on or otherwise factor in your credit score. That means getting a Solo 401(k) loan may be far easier than a loan through a traditional lender.
  • You pay interest to yourself.  Even though you still need to pay interest on a 401(k) loan, that interest goes back into your retirement account. When you pay interest on a traditional loan, the interest goes to the lender.
  • It won’t affect your credit score. When you take out a traditional loan, the lender typically reports it to the major credit bureaus, affecting your debt-to-income ratio. Missed payments or defaults are also reported, and all of these things can lower your credit score. When you take a loan from your Solo 401(k), you are borrowing from yourself, so the transaction or any missed payments or defaults are not reported to the credit bureaus.

Of course, there are downsides to taking a loan from a 401(k). For instance, removing a large portion of funds from your account means you’ll miss out on potential earnings you would have gained if the fund remained in your account. And if you don’t repay the loan on time, you’ll face tax consequences.

Always weigh the pros and cons of a Solo 401(k) loan before determining the best option.

For more information on self-directed retirement accounts, check out the differences between a solo 401(k) vs. self-directed IRA. And if you’re interested in opening a solo 401(k), read more about rolling over your employee-sponsored 401(k).

FAQs

What are the eligibility criteria for obtaining a Solo 401(k) loan?

You can take a Solo 401(k) loan if your account provider allows loans to be drawn against the account. How much you can borrow depends on three factors: IRS rules, your Solo 401(k) account balance, and plan provider rules.

The IRS limits Solo 401(k) loans to the lessor of $50,000 or 50% of your vested interest. If you have less than $10,000 vested, you can borrow up to $10,000. Plan providers can choose to implement further lending maximums.

Are there restrictions on how the loan funds can be used?

No, there are no restrictions on using funds from a Solo 401(k). Common reasons to take out a Solo 401(k) loan include:

  • Using funds as a down payment for a home.
  • Paying off medical debt.
  • Paying for educational expenses.
  • Using funds to pay for a wedding.
  • Upgrading or making major improvements to residence.

What happens if I default on a Solo 401(k) loan?

If you default on a Solo 401(k) loan, the IRS considers the loan balance a distribution.  If you borrowed from a traditional Solo 401(k), you’ll have to pay taxes on the distribution. If you’re under the age of 59 ½, you’ll also need to pay a 10% unqualified withdrawal penalty.

If you borrow from a Roth Solo 401k and default on the loan, you’ll still need to pay a 10% withdrawal penalty, but the additional tax implications vary. Because Roth 401(k)s are funded with after-tax dollars, as long as your plan is at least five years old, you’ll only need to pay taxes on earnings if you’re under 59 ½.