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How do I take out a loan from my Solo 401k account ?
You can borrow up to 50% of your vested account balance or $50,000, whichever is less. You usually have a maximum of five years to repay the loan, unless you are borrowing for a first home, which allows a longer payback.
If you've got a financial emergency, and the only choice you have is between borrowing from your 401(k) plan or pulling the money out as a hardship distribution before you're age 59 1/2: borrow the money. There is no penalty on borrowing, but there is a 10% penalty on early distributions before age 59 1/2.
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SAMPLE
401k Plan
LOAN APPLICATION
Participant Name:____________________________
Address:__________________________
City, State, Zip:______________________________
Married: [ ] Yes [ ] No
Date of Hire________________________
Social Security Number:_______________________
This form is used to request a Participant loan. If the loan is approved, you will also be required to sign a promissory note.
1. Loan requested: $________________. (May not be greater than 50% of your vested accrued benefit under the Plan.)
2. Term of loan: _____ years. (Must not be greater than five years, unless such the is used to acquire your principal residence.
3. Payroll frequency: __________. Requested pay date for first deduction: __________. Please note that it may take several weeks to process the loan application. The first deduction will be taken on the later of (i) the date listed in this item 3, or (ii) the first pay date for the pay period that starts after the loan application is approved.
4. Other loans. Please provide the following information on all other plan loans that you have received from any qualified Plan sponsored by THE COMPANY Please note that you may not have more than 5 loans outstanding at any one time.
Loan Balance - Date of Loan - Loan is in default - # of remaining payments
_________________________
_________________________
_________________________
_________________________
_________________________
I have read and I agree to the Plan's loan procedures. I agree not to withdraw any benefits from the plan while this loan application is pending. My benefit is not subject to a qualified domestic relations order. All information provided by me in this application is true and accurate.
________________________________ _______
Participant's Signature Date
As Plan Administrator, I hereby authorize the above loan.
________________________________ _______
Plan Administrator's Signature Date
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There are five requirements for Solo 401k loans.
To avoid your loan being determined as a taxable distribution, your plan's loans must meet the following requirements:
Plan loans must:
1. Be available to all participants
2. Not be available to highly compensated employees in an amount greater than that available to non-highly compensated employees,
3. Be made according to the requirements of the plan loan policy
4. Use a reasonable rate of interest and
5. Be secured by your account or other collateral
The IRS rules state that the Solo 401k loan policy must:
1. Specify the maximum loan amount
2. Specify the maximum repayment period
3. Require an enforceable agreement and
4. Require level amortization of payments.
What is required to create an enforceable agreement?
The terms of the loan agreement must be in compliance with the regulations. An enforceable agreement is one that has:
1. The loan amount,
2. The date of the loan,
3. The repayment schedule
4. The agreement in writing
What is a reasonable rate of interest?
A reasonable rate of interest is an interest rate that "provides the plan with a return similar to the interest rates charged by persons in the business of lending money for loans which would be made under similar situations."
As a standard interest rate, the prime rate + may be the best to use for the following reasons:
- It is consistent among all banks.
- It is published daily.
- It is a rate charged by financial institutions.
Adding one or two percent to the prime rate does make the interest rate charged to the participant more consistent with general consumer rates, as individuals can rarely get a loan at the going prime rate.
What does adequately secured mean?
Adequately secured simply means the Solo 401k plan making the loan has some protection against default. The Department of Labor defines adequately secured by no more than 50% of the participants vested accrued account at time of origination of the loan.
What are the minimum and maximum loan amounts?
The IRS regulations limit the maximum loan amount to the lesser of:
- No more than 50% of the participants accrued account, or
- $50,000. The $50,000 maximum must be reduced by the difference of the highest outstanding balance from the previous year minus the current outstanding balance.
The plan loan policy may set a minimum loan amount. As long as the minimum amount is $1,000 or less, the plan does not violate the requirement that loans be made available to all participants on a reasonably equivalent basis.
How frequently must loan payments be made on a plan loan?
Loan payments must be made at least quarterly. Principle and interest must be amortized to require substantially level payments over the term of the loan. Thus, balloon payments and duplicate payments are prohibited.
What is the maximum repayment period for a plan loan?
Plan loans must be repaid within five years from the date of the loan. However, if the purpose of the loan is to acquire a primary residence, the loan term may exceed the 5-year limit.
What is the annual percentage rate (APR)?
The annual percentage rate or APR is the annual equivalent rate of interest the participant is paying on the loan when interest-like fees are included. It reflects the cost of borrowing and gives the participant a method to compare the true cost of loans.
For example, if a participant takes a loan of $1,000 to be paid back over 5 years with a simple rate of interest of 8% and no fees, the APR will equal the interest rate of 8% (assuming a monthly payroll).
Is there a maximum Interest Rate allowable on a plan loan?
The maximum Interest Rate may be limited by state law.
Do I need my spouse's signature to take out a loan?
Solo 401k plan loans do not require spousal consent.
Other 401k plans, look to the plan's loan policy for whether or not it is necessary to obtain the participant's spouse's consent prior to approving a plan loan. Usually, only plans with joint and survivor benefit provisions require spousal consent
The spouse's signature on the consent form must be witnessed by the plan representative or a notary public.
Must loans be repaid using payroll deductions?
The law does not require solo 401k loan payments to be made using payroll deductions. However, bank checks are often the method of choice for Solo 401k plans for ease of processing the payments by the recordkeeping service provider.
What is the deadline for depositing loan payments ?
Loan payments are sufficiently similar to contributions. Therefore, participant loan payments must also be deposited as soon as they can be segregated from the employer's general assets.
What happens if I default on a loan or stop loan payments?
When you stop loan payments, there is a 180 day period in which you can make up the unpaid loan deposits. After the 180 day period the loan goes into default and the remaining loan balance is considered a distribution from the plan. And, like all distributions, a Form 1099-R will be issued and the balance reported to the IRS on the annul Form 1096 and Form 945
Can a 401k loan be made to a participant after the participant has defaulted on a prior loan?
A defaulted loan may mean that the participant cannot take another Solo 401k loan. There are two issues to consider. First, the solo 401k loan policy may prohibit a loan after default. If so, the participant would not qualify for another loan. Second, when the solo 401k does not prohibit the loan, the IRS imposes additional duties on the plan. If the defaulted loan resulted in a deemed distribution and has not been repaid no additional loan may be made unless:
- The employer and employee execute an agreement to make the payments on the new loan using payroll deductions, or
- The new loan is secured by property in addition to the participants accrued benefit.
- For example, the participant could pledge his or her vehicle as collateral for the loan. Of course, this would mean that the security interest in the vehicle would have to be perfected
Can a participant refinance an outstanding Solo 401k loan?
With a Solo 401k Plan loan you can refinance. The amount of the existing loan is considered when determining the amount of the subsequent loan and has the effect of limiting each subsequent loan. In addition, if the loan term of the subsequent loan extends beyond the maximum term of the original loan, both the original loan and the subsequent loan are considered outstanding for purposes of determining the maximum loan amount available to the participant. However, this restriction does not apply if the original loan and the subsequent loan are each amortized over a term that does not extend beyond its original maximum loan term.
Sample Solo 401k Plan Promissory Note
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Solo 401k Plan
PROMISSORY NOTE
I, ___________________________, promise to pay to the order of the trustee(s) of the Sample 401k Plan, the sum of ______________________________. Such amount shall bear interest on the unpaid balance at ________ percent per annum and shall be repaid in _______ equal installments [each month/each pay period] commencing on __________ and the same day of each period thereafter until paid in full. All payments shall include principal and interest. This note will become due and payable upon termination of employment with MyTotem Solutions, Inc..
I hereby assign the corresponding amount of my interest in the Sample 401k Plan (up to 50%) to the trustee(s) under the plan, as security for payment of all sums that may become due under this promissory note. In the event said promissory note is not paid in full in accordance with the conditions thereof, then that portion of my accrued benefit equal to the amount of principal, interest and other amounts due under said promissory note (but not in excess of the interest assigned hereunder) shall be deducted from my benefit and applied by the trustee in payment and satisfaction of said promissory note. Upon full payment of all amounts due under that promissory note, this assignment shall become null and void.
This note shall be in default if any required payment hereunder is more than ninety [90] days past due and I have not cured such default within ninety [90] calendar days after mailing of a notice of such default. Upon default, the holder of this note may accelerate the entire outstanding balance and any interest thereon, and declare said amount due and owing.
Dated this ________ day of ________________, 2008
_______________________________________
Borrower
_______________________________________
Trustee
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