Self-Directed Solo 401(k) Loan Rules and Regulations - Part 1

Assuming the self-directed solo 401(k) plan contains loan provisions that allow for participant loans, as Nashional Self-Directed’s plan document does, as trustee you are allowed to borrow from your solo 401(k). (Part 2 can be found here.)

What is the interest rate that must be charged on the solo 401(k) loans?

Rates considered reasonable by the DOL for loans secured by a participant’s solo 401(k) account balance range from:

• A certificate deposit rate plus 2 percent

• To the prime rate plus 1 percent.

The DOL regulations require that the reasonable rate of interest standard must be reviewed at each time a loan is originated, renewed, renegotiated, or modified. As such, a solo 401(k) plan sponsor cannot simply choose a loan rate at the time the plan is setup and use that rate continuously. Loan rates must be reviewed and updated as often as needed to be in line with the current CD or Prime rate.

How is my participant loan secured?

It is secured by up to 50 percent of the present value of a participant’s account balance. This is determined at the time the solo 401(k) loan is made.

If a solo 401(k) participant borrows one half of his or her account balance and then takes a solo 401(k) hardship distribution before the loan is repaid, he or she will still be in compliance with this rule.

Does the creditworthiness of the solo 401(k) borrower need to be reviewed?

No, the DOL does not require anyone to review financial statements or other indications of creditworthiness in order for the solo 401(k) participant to take out a loan.

Are there any restrictions on how a solo 401(k) loan can be used?

No, there are not. As long as the employer does not place any restrictions on use of the loan that would benefit itself, a fiduciary, or other party in interest, there is no reason why a participant cannot independently make the decision to use loan proceeds in a way that would benefit themselves or any other restricted party.

Are there any other restrictions on solo 401(k) participant loans?

Yes, it does. The participant taking out the loan must intend to repay it. It is important that the plan administrator and participant be diligent in ensuring that payments due on loans are made on time.

DOL & IRS Solo 401(k) Loan Requirements

1. The loan must have level amortization, with payments at least quarterly.

2. The loan must be repaid within five years, or 15 years if used for a primary residence.

3. The loan must not exceed the statutory limits.

4. The loan must require a reasonable rate of interest.

5. The loan must be adequately secured.

Check back next week for Part 2 which will include additional information including the grace period for late payments, avoiding taxation on the loan amount, and what to do if you take out more than the allowable limit.