Did you know that 401(k) account owners, including holders of Solo 401(k) plans, can borrow up to $50,000 from their account? This personal loan offers a versatile line of credit, including cash to invest in other opportunities that may not otherwise be accessible within the plan itself.
Given the flexibility, 401(k) loans can be an enterprising way to grow and diversify your retirement account balance. In this article, we will discuss why and when an investor may want to consider a 401(k) loan.
First, let’s review the IRS rules for 401(k) personal loans:
- The maximum loan duration is five years. One exception exists when the funds are used to purchase the account owner’s “primary” residence, which may allow for the loan duration to be extended.
- Maximum loan amount of $50,000 or one-half of the overall plan value, whichever is greater.
- Loan principal payments are required. In loan parlance, the loan must be “fully amortized,” which means no interest-only loans. Furthermore, the loan must be repaid in equal installments, including both principal and interest.
- A “reasonable” interest rate is required. Lenders and debtors (you in both cases) cannot charge 0% nor unusually high-interest-rate loans.
- Loan payments need to be made at least quarterly, though they can be more frequent.
Now that we’ve covered the IRS basics, let’s look at some of the more common reasons investors may take a loan from their 401(k):
- Personal Reasons: Because there are no IRS guidelines stating what you must use a 401(k) loan for, you have the flexibility to use the loan as cash to pay bills, eliminate debt, or any other investment purpose. For example, you could use the 401(k) funds to pay off a car loan. Instead of paying the dealer or bank interest, an individual could pay themselves and grow their 401(k).
- Purchase of a Primary Residence: When borrowing for the purchase of a primary residence, an individual can borrow up to $50,000 from their 401(k) with a loan duration lasting longer than 5 years. You do need to keep in mind that the plan documents must have specific language about borrowing for the purchase of a primary residence and outline the maximum length of the loan. Practically speaking, the loan duration could be anywhere from five to 30 years. Please note this only applies to a primary residence; you cannot get the extended loan duration for second homes or investment properties.
- Investing Beyond Your Existing 401(k) Platform Lineup: Investors may wish to use retirement funds to invest in assets beyond their plan-approved platform lineup (e.g., the typical 10-20 mutual funds). In addition, 401(k) loans can provide a path to investing in businesses you own as borrowed money from a 401(k) is not considered retirement money. More broadly, 401(k) loans can be used for direct real estate investing, a popular option here at New Direction Trust Company, as well as virtually any other asset class you may select.
Does your 401(k) plan offer the personal loan feature? It’s easy to determine: simply contact your plan administrator and ask. For Solo 401(k) plans such as those offered by NDTCO, the account owner is often the plan administrator and the personal loan feature is generally established when the plan is created.
The 401(k) personal loan offers a unique opportunity to access retirement funds without the potential tax implications of distributions. To learn more, please don’t hesitate to give us a call at 877-742-1270 or send us a message through the Client Portal.