QRPs & Checkbook Self-Directed Solo 401k Plans, also known as Checkbook QRPs, provide a powerful feature that can be leveraged in so many ways: A Checkbook QRP & Solo 401k Loan.
QRP Loan Proceeds can be used to finance anything you’d like and the interest payments are made to yourself in the form additional deposits to your tax-sheltered QRP. Think of it as a QRP line of credit, requiring no bank underwriting, credit checks, or paperwork processing. (Caveat: Of course, it’s NOT truly a “line of credit” and that calling it a line of credit can be misleading. More on that below.)
Checkbook 401k Loan Interest Payments can be viewed as a way to make backdoor contributions – beyond the Solo 401k contribution limits – to your Checkbook Solo 401k tax advantaged retirement accounts. Once those interest payments are paid to your Solo 401(k) plan or QRP, those funds become additional plan assets that can be invested tax-free.
- Do you have debt to pay off?
- Do you want to purchase a new vehicle?
- Pay for education?
- Or, would you like to make an investment outside your QRP or Solo 401k?
The Checkbook Control QRP & 401k loan feature is your best option and in this post will cover all that you need to know to legally take advantage of this Checkbook QRP feature.
Can I borrow money from my Self-Directed Checkbook Solo 401k Plan or QRP?
Yes, you can take a loan from your Checkbook Solo 401K Plan – provided you adhere to the IRS rules and that such loan is permitted by your Solo 401K Plan Documents. You must follow the rules for Solo 401(k) loan limits, Solo 401(k) loan interest rates, and Solo 401K loan repayment schedule.
Is a Checkbook Solo 401k Loan a Prohibited Transaction?
No, Solo 401k Loans to plan participants that follow the tax and labor law rules are not Prohibited Transactions. Although lending between a Solo 401k Plan and disqualified persons is a prohibited transaction, a limited exemption to the rules is provided for 401k loans. See IRC 4975(d), IRC 4975(f)(6), USC Title 29 Section 1108(b)(1), USC Title 29 Section 1108(d), 29 CFR 2550.408b-1.
Loans made to disqualified persons or parties-in-interest (the ERISA equivalent of a disqualified person) are NOT prohibited transactions if such loans are:
- available to all plan participants on a reasonably equivalent basis,
- not made available to highly compensated employees in an amount greater than the amount made available to other employees,
- made in accordance with specific provisions set forth in the plan documents,
- bear a reasonable rate of interest (see below), and
- adequately secured (see below).
Is a Checkbook Solo 401k loan treated as a taxable distribution?
No, Solo 401k loans that that follow the loan guidelines of IRC 72(p) are not deemed distributions and are not taxable.
To qualify for treatment as a loan – and not as a taxable distribution – Solo 401k loans must:
- not exceed allowable limits
- provide for repayment within 5 years, unless the loan purpose is the acquisition of a principal residence
- require substantially level amortization over the loan term (payments can’t be interest only)
- require payments no less often than quarterly
What are the Checkbook Solo 401k loan limits?
Solo 401k loan limits, per IRC 72(p), are the lesser of:
- $50,000 and
- the greater of:
- 50% of the participant’s vested account balance and
- $10,000 – if security is provided
If there are prior outstanding Checkbook Solo K participant loans, the calculation is more complex.
Solo 401(k) loans must be adequately secured. Up to 50% of the present value of a participant’s account can be used as security. If the loan amount exceeds 50% of the participant’s vested account balance at the time of loan origination or renewal, additional security is required. See CFR 29/2550.408b-1(f).
What is the loan limit for a Checkbook Solo 401k plan participant that has taken prior loans?
If you took a loan within one year prior to the new loan, the maximum loan amount is reduced by the highest outstanding balance during that year. The maximum is reduced even if you paid back the first loan in full before taking a second loan.
In the words of the Tax Code in Section 72(p)(2)(A), the maximum amount allowable for a plan loan is:
(i) $50,000, reduced by the excess (if any) of—
- (I) the highest outstanding balance of loans from the plan during the 1-year period ending on the day before the date on which such loan was made, over
- (II) the outstanding balance of loans from the plan on the date on which such loan was made, or
- (I) one-half of the present value of the nonforfeitable accrued benefit of the employee under the plan, or
- (II) $10,000.
What is the allowed repayment period for a Solo 401k Plan participant loan?
- The plan participant must:
- repay a plan loan within five years and
- must make payments at least quarterly.
- The law provides an exception to the 5-year requirement if the employee uses the loan to purchase a primary residence.
Are there any exceptions to the 5-year repayment requirement?
Yes! The 5 year repayment requirement does not apply to any loan used to acquire any dwelling unit which within a reasonable time is to be used (determined at the time the loan is made) as the principal residence of the participant. [§ 72(p)(2)(B)(ii)]
- A loan is not required to be secured by the dwelling unit that will within a reasonable time be used as the participant’s principal residence in order to satisfy the requirements for a principal residence plan loan.
- Refinancing cannot qualify as a principal residence plan loan.
- However, a loan from a qualified employer plan used to repay a loan from a third party will qualify as a principal residence plan loan if the plan loan qualifies as a principal residence plan loan without regard to the loan from the third party. (Reg. § 1.72(p)-1, Q&A-5,-6, -7, and -8)
- Neither the Tax Code nor the IRS regulations specify a maximum loan period for principal residence plan loan! An illustrative example in the IRS regulations uses a 15-year loan period. [Reg. § 1.72(p)-1, Q&A -8(b)]
- The maximum loan period used by plans is 30 years, with many plans providing for far shorter repayment periods.
How is each Solo K loan payment determined? Can it be interest only?
- Payments must be made in substantially equal payments that include principal and interest and that are paid at least quarterly.
- In other words, loan payments are amortizing and can NOT be interest only.
What is a reasonable rate of interest for a Checkbook 401k loan?
The code and regulations do not specify a rate of interest. The regulations say only that the rate must provide the plan “with a return commensurate with the interest rates charged by persons in the business of lending money for loans which would be made under similar circumstances (CFR 29/2550.408b-1).” The courts addressed this issue in McLaughlin v. Rowley and Brock v. Walton.
Accepted industry practice is to charge prime plus 1%-2% as the rate of interest on a Solo 401k Loan. The WSJ Prime Rate is a commonly used benchmark.
The appropriate rate of interest must be determined at the time of the initial loan and must be reassessed at the time of any renewal or refinancing. Remember that the interest you pay is going into your retirement account and will grow tax-advantaged for your benefit.
What type of documentation is required for Solo 401k Plan loan?
An Individual K Loan must be evidenced by an enforceable agreement that demonstrates compliance with 401k loan rules. See CFR 26 1.72(p)-1. At a minimum the loan documentation must:
- be legally enforceable
- specify the amount of the loan
- specify the date of the loan
- specify the repayment schedule
What can a SD Checkbook One Participant 401k Loan be used for?
The loaned funds can be used for any purpose that you choose. You can use them to start a business, pay off high interest debt, pay college and education expenses, pay bills, purchase collectibles, and any other purpose. Once loaned to you, the funds are yours to spend and are not subject to any retirement plan rules.
Remember, the loan is to you, not your business. Once you get the money in your personal account you can use them in any way you like. Likewise, loan payments should come from your personal funds.
Checkbook Solo 401k loan interest payments are a personal expense that is not tax deductible on your income tax returns.
Unlike interest on credit card debt and consumer financing, the interest paid on your Solo 401k loan will come back to you – plus compounded investment returns.
Can loans be taken from a Solo 401k Roth subaccount?
Yes, loans can be taken from Roth Solo 401k accounts. We recommend that you take a loan from either your pretax, after-tax, or Roth 401k accounts and not take a single loan from multiple account types. This will simplify recordkeeping.
Can I take a loan from my IRA-LLC or Self-Directed-IRA?
If you qualify for a Self-Directed Solo (k), you can rollover IRA funds to a Solo (k) and then borrow the funds. Roth IRAs can’t be rolled over to a Solo 401k.
What happens if a Solo 401k loan is not repaid?
Solo 401k loans that are not paid in accordance with the loans terms are deemed distributed, with associated taxes and penalties due. A cure period may be available to you, depending on your plan docs.
What happens if Solo 401k loans exceed the allowed amount?
The excess amounts will be deemed distributed, with associated taxes and penalties due.
For additional information about borrowing from your Solo 401k see the IRS page about retirement plan loans.
Your Self-Directed Uni(K) loan option is one of its most attractive benefits. In fact, for some investors the QRP Loan feature is the determining factor in their plan selection. With the QRP loan info in this post, you can keep your Checkbook Solo 401k plan loan compliant while leveraging its powerful advantages.
IRS Plan Loan Resources
- Participant Loans Slide Deck