Are you a small business owner? If yes, this quote might have more relevance to your financial life than anyone else’s. Being a small business owner isn’t the easiest of the jobs in the current U.S. economy.
The last recession triggered massive changes in the lending landscape, especially for small business owners. A Wall Street Journal report highlighted a considerable decline in small business lending from the nation’s 10 largest banks, at $44.7 billion in 2014 against $72.5 billion in 2006. It is important to note that small businesses have to rely more on credit sources than their larger counterparts, especially during the offseason.
In lieu of traditional funding, as many as 40% of micro-business owners end up using their personal savings and retirement money to fund or grow their business. This can jeopardize the owner’s retirement goals. Withdrawing early from a retirement plan can also lead to expensive penalty and tax charges.
But what if you could use your retirement savings to grow your business without taking a hit on your long-term retirement goals? As surprising as it may sound, there is an option available to meet this need.
A Solo 401(k) is an IRS-approved retirement plan that allows a loan feature, although its availability may vary from one provider to another. Before diving into the loan option, let us find out more about this retirement plan.
Basics of Solo 401(k) Retirement Plans
Solo 401(k)’s target owner-only businesses and self-employed individuals. They have gained popularity over the past couple of years, especially because of their higher contribution limits and other advantages.
- Contribution Limits: You can contribute up to $59,000 in 2016, including $6,000 in catch-up contributions for professionals above 50 years of age.
- Multiple Investment Options: A self-directed Solo 401k comes with a wide range of investing options, starting with real estate, tax liens/deeds, precious metals and private lending, while providing traditional investment options as well.
- Easy Management: Considering the plan’s primary audience, annual filing is not required for accounts with an asset value under $250,000.
- Roth Solo 401(k): If your income is higher than the Roth IRA eligibility criteria, a Roth Solo 401(k) keeps the option open for you. Irrespective of your income level, you can contribute up to $24,000 to your Roth Solo 401(k) account in 2016.
Solo 401(k) Loan Features
In addition to the above list, the IRS allows plan owners to borrow up to 50% of their account balance to a maximum limit of $50,000. In case of multiple owners, each participant can borrow up to $50,000 or 50% of the account balance, whichever is lower.
While it is not encouraged to borrow from your retirement account unless it is the last resort, a Solo 401(k) loan can help cover the short-term cash needs of small businesses. This can help business owners meet their financial obligations without taking a tax hit. And that’s not the only benefit, as you can see below:
- Solo 401(k) loans are tax-free and penalty-free.
- There is no credit check to take out the loan.
- The loan comes at a low interest rate (prime rate plus 1%).
- Interest is paid back to the 401(k) plan, instead of to a lender.
- The repayment period is up to five years, with at least one payment per quarter
- You can use this loan at your own discretion.
Choosing a Plan
The many features of a Solo 401(k) gives it an advantage over traditional retirement accounts, but it is important to note that the specifics may vary from one provider to another.
Starting with investment options, the IRS doesn’t prohibit real estate investments, but at the same time, it doesn’t necessarily require retirement custodians/plan providers to offer such investments to customers. Similarly, the loan feature of Solo 401(k) isn’t a mandatory option.
On the contrary, if you choose a self-directed Solo 401(k) plan, you can manage your own investments. For instance, a full-time real estate investor may find it comforting to invest in real estate, whereas a technology consultant may find it more sensible to invest in the local tech startups.
Further, some custodians provide a ”checkbook control” feature, allowing you to invest at your discretion; hence, eliminating custodial consent from the process.
The key is to ensure that your Solo 401(k) provider offers all of the features that you’ve determined you need. When used with the right strategy, a Solo 401(k) plan can not only offer financial help at your hour of need, but it can set you up for financial success.