Pros and Cons of Borrowing From Your Self-Directed 401K

You may have used up your other borrowing avenues such as a home equity line of credit  or personal line of credit, but you have a self-directed 401k (aka solo 401k) sponsored by your self-employed business that allows for 401k participant loans. The advantage of a self-directed 401k over other 401k plans such as a traditional 401k is that you can serve as the trustee of the plan and can thus elect for the 401k plan to allow for participant loans, an option not always available with full-time employer 401k plans. Following are items to consider before borrowing from your self-directed 401k plan. 

Advantages

No Credit Check: Borrowing from your self-directed 401k does not result in a credit score checkup. 

Competitive Loan Interest Rate: The participant loan interest rate is based on the current prime rate plus one point, not on your personal credit history. 

Loan Amount: You can borrow 50% of the self-directed 401k value, up to $50,000.

Paying Your Own 401k Back: The participant loan payments including the interest flow back to your own 401k, so not to the bank. 

Delay Paying Taxes: Since the participant loan payments flow back to your self-directed 401k, you don’t pay taxes on the interest payments until distributions commence at retirement age. 

Disadvantages 

Less Money to Invest: Borrowing from your self-directed 401k plan results in having less funds to put to work by investing on a tax deferred basis. 

Loan Default: If you miss a payment and the payment is not made up by the grace period deadline, you run the risk of the loan going into default, resulting in the payment of taxes and possibly distribution penalties. 

No Longer Self-Employed: If you stop being self-employed, the outstanding self-directed 401k loan will need to be paid back in full or treated as a distribution.

Share on Facebook

Tweet

Save