Plan owners of Solo 401k plan are offered one of the most flexible options: the Solo 401k loan option. The loan option allows them to borrow up to $50,000 or 50% of the account total value, whichever is less. This can provide quick cash in a short notice. The loan application process is much faster and simpler than a regular bank loan. On the down side, the money is taken away from the retirement plan and investment opportunities. Is borrowing from the Solo 401k plan a wise decision?
Penalty free and Tax free loan
The good thing about the Solo 401k loan option is that the loan will cost you much less than borrowing anywhere else. The loan interest is Prime rate plus 1 percent, which is lower than most consumer loan. And since you are allowed to borrow for any reason, the loan application process is very simple and often gets approved much quicker. Therefore, if borrowing is definitely a must, then borrowing from your own Solo 401k plan could be a preferable solution.
Lower interest but possibly higher payment
Often, plan holders may opt for the Solo 401k loan to pay off their debt, either in form of credit card debt, mortgage or student loan. The upside of this strategy is that, plan holders can take advantage of the low interest of the Solo 401k loan to save on overall payment. Instead of paying hefty credit card rate, the plan owner can borrow from his or her Solo 401k plan, pay off the credit card balance, and pay the low interest on the Solo 401k loan instead.
When doing so, however, plan holders need to also keep in mind that while the interest rate is lower, the payment period can also be shorter. A mortgage or a student loan can be paid back within 10 or 20 years or even longer. When the payments are spread out over a long period of time, you can make smaller payment for each period. A Solo 401k loan, however, is payable within 5 years. When facing larger debt, you need to calculate the loan installment and decide if you can afford to pay back the loan that quickly before making the decision. To calculate your loan payment, you can use the Solo 401k loan calculator here. Remember, if you fail to pay back the loan within 5 years, taxes and penalty will apply and add to the loan cost.
The option of Solo 401k loan can be a financial life saver for certain circumstances. However, like most financial tools, it needs to be used wisely and with cautions. A smart use of the Solo 401k loan can save plan holders thousands of dollars in interest payment and get them out of financial hardship. Abusing the option, however, will leave the retirement funds empty and defeat the purpose of having a Solo 401k. Therefore, consider all your options before making your carefully planned actions.