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A solo 401k, also known as an individual 401k, allows people who are self-employed to invest in a 401k plan for retirement. The limits for investing in a solo 401k are much higher than for investing in an Individual Retirement Account (IRA) each year. As with a 401k offered through an employer, you can borrow money from your solo 401k without penalty, provided you set up a borrowing account.
Why Borrow from Solo 401k
You may encounter times in life when you need more money that you expected, for example, when buying a house or paying for school. Although you can usually borrow from a 401k any time for any reason, you may want to reserve borrowing from your retirement until a time when you absolutely need to. Borrowing from a 401k can be a smart move, though, since you are paying the interest to yourself. The loan will also not impact your credit history and you will not need a credit check to get one.
Borrow up to 50 percent of the amount in your 401k or $50,000, whichever is lower. If you have $80,000 in your solo 401k, you can only borrow $40,000, for example. You will not have to pay tax on the amount of the loan as long as you repay it as arranged. Usually, you have up to five years to repay the loan. If you use the loan to purchase a home, you may have up to 15 years to repay it.
You lose the tax advantage of a 401k if you take money out as a loan. Although you are not taxed on the loan, payments made to repay the loan are taken from your after-tax income, rather than pre-tax income, which is what you use to contribute to a 401k. Depending on your financial institution, you may have to pay fees to take out a loan, to set up an account that allows you to borrow and if the amount in your 401k goes below a certain dollar amount after you've borrowed from it.
Early Withdrawal vs. Loan
Instead of a loan, you can choose to withdraw money from your solo 401k. Withdrawal is typically not as good of an option, as you will usually have to pay a 10 percent penalty if you are under age 59 1/2 as well as income tax on the amount. Some early withdrawals are exempt from the penalty, though. If you become disabled or have high medical expenses, you will not have to pay the penalty on an early withdrawal.
- CNN; Ultimate Guide to Retirement; Individual 401k Plans
- "Los Angeles Times"; Solo 401k Lets Self-Employed Shelter More of Their Income; Kathy M. Kristof; May 2011
- MSN; When a 401k Loan Is a Smart Move; Kimberly Palmer; January 2011
- "Kiplinger"; The Pitfalls of a 401K Loan; Kathryn A. Walson; October 2008