We received the following good questions from a client, and have provided answers below to help others understand the solo 401k distributions rules which can be complex.
We are planning on a custom home construction and had a couple of
questions regarding my 401K account
currently we have a balance of 400K in the account and need 120K for
– can we draw money from the 401K account as loan for the down payment
on the home without penalty?
– can we take the money out and put back the whole amount within 60
days as allowed in rollovers?
– if we decide to take the money out ( pay 10% early withdrawal
penalty and the federal taxes owed) can I still continue the solo 401K
plan with the rest of the amount in the account.
Since you are under age 59 1/2, you can only distribute funds that you transferred to the solo 401k plan from IRAs and/or former employer 401k plans.
If you qualify for the solo 401k distribution and decide to proceed, a distribution form will need to be filled out and the information collected will be used to populate the Form 1099-R to report the taxable distribution to the IRS. If you are a client of My Solo 401k Financial, CLICK HERE to fill out the partial distribution form.
As far as redepositing the solo 401k distribution within 60 days from the date of the distribution, this is possible if you qualify for the distribution as mentioned above. However, you will only be able to rollover/deposit 80% of the funds from the distribution back into the Solo 401k unless the 20% deficit is covered by you personally. Reason being, solo 401k distributions are subject to an upfront 20% mandatory federal tax withholding at time of the distribution.
Yes, you can still continue with the solo 401k plan as long as you continue to meet the eligibility requirements (i.e., you are still self-employed, don’t employ any full-time W-2 employees, and don’t employ W-2 employees who have worked more than 500 hours per year for 3 consecutive years starting in 2021).
Lastly, another option instead of taking a distribution from the solo 401k plan is to process a solo 401k participant loan which would allow you to borrow 50% of the solo 401k balance not to exceed $50,000.
Following are some quick facts regarding the solo 401k participant loan rules.
Each participant can borrow from the solo 401k provided each has a solo 401k balance; however, the solo 401k loan calculation is based on each solo 41k participant’s respective loan balance–not the entire value of the solo 401k plan.
The solo 401k loan does not affect your personal credit or business credit score because you are borrowing from the solo 401k plan; therefore, there is no credit check.
The Solo 401k loan term is 5 years for general loans.
The Solo 401k loan term can be more than 5 years not to exceed 15 years if used to purchase principal residence for you as trustee/participant of the Solo 401k.
Solo 401k loan payments are made either monthly or quarterly.
Solo 401k annual contributions from self-employment income cannot be used/applied towards payment of solo 401k participant loans.
Solo 401k participant loan payments must be made with personal funds, not business funds or solo 401k funds.
Since the solo 401k participant is borrowing from the solo 401k plan, at time of loan the loan proceeds must flow to the solo 401k participant’s bank account, not her business. Once the funds are in your personal bank account, you can then disburse them however you wish including placing them in your own business bank account.
The interest rate for a Solo 401k loan is either: A certificate deposit rate plus 2 percent or the prime rate plus 1 percent.
Solo 401k Loan payments are fixed payments consisting of interest and principal
Solo 401k loan rules do not allow for Interest only payments or principal payments only.
Each solo 401k participant can borrow from his or her respective solo 401k balance. For example, if both spouse’s are participating in the solo 401k plan and have account balances, each can borrow up to the statutory limits described below.
The maximum Solo 401k loan amount is either 50% of account balance or maximum amount of $50K.
– Example 1: Solo 401k balance is $50K; 50% of $50K = $25K (the Solo 401k maximum loan amount)
– Example 2: Solo 401k balance is $150K; 50% of $150K = $75K; however, the maximum permitted Solo 401k loan amount is $50K
– The minimum Solo 401k loan amount is $1,000.
The Solo 401k rules require the following proper Solo 401k loan documentation:
– Solo 401k Loan Agreement
– Solo 401k Loan Application
– Solo 401k Loan Payment Amortization Schedule