As everyone is well aware now, COVID-19, also known as coronavirus, has crippled the entire world. Especially, in the densely populated areas of the Unite States. Schools are closed, sports have been canceled, most nonessential businesses have closed up shop as well. The economic impact is being felt by tens of millions of people. The CARES act is $2 trillion stimulus package enacted on March 27, 2020 to help Americans deal with this situation. This article will focus on the CARES Act and the Solo 401(k) loan.
What is a Solo 401(k)?
A Solo 401(k) is a retirement plan designed for the self-employed. It can only be utilized by individuals who have self-employment income without the presence of full-time employees. Therefore, if you are a small business owner with no full-time employees, other than a spouse or business partner, you can set up a Solo 401(k). Once you start hiring on more help, you will need to switch to a more conventional plan.
A Solo 401(k) is the ideal plan for the self-employed. Since you are the one in control of all the decisions, you can choose the plan that works best for you. With a Solo 401(k), you can opt to have Roth and loan options, choose your own investments and gain checkbook control of your funds.
Our focus today is the loan feature. If your plan doesn’t have one, then, obviously, you cannot borrow from the plan. This is the case with many workplace-sponsored plans. If you work for someone else, the plan details are in their hands, not yours. If so, you need to see if a loan is even an option. Again, if you have a Solo 4101(k), you may already have a loan feature. If not, you can generally add one by contacting your administrator.
CARES Act and the Solo 401(k) Loan
Once you are set up with a 401(k) loan option, you can take advantage of it borrow what you need. Under normal circumstances, you may take out up to $50,000 or 50% of your account balance, whichever is less. The CARES Act allows you to borrow twice that amount – $100,000. Having these funds available to you during this financial crisis is huge.
If you don’t have an emergency fund (or have depleted it already), you have options. The Solo 401(k) loan is one of the best provisions in the CARES Act. Instead of having to take a taxable distribution, you can borrow the funds instead. In fact, your first loan repayment doesn’t have to to occur for a year. This essentially extends the time you have to spread out the payments from five years to six. Payments then must be at least quarterly at an interest rate of at least Prime. The Prime Rate stands at 3.25% as of May 1, 2020.
The great thing about borrowing from your 401(k) plan is that all the interest due on the loan gets paid back to your plan. Instead of borrowing money from the bank, you borrow it from yourself and pay all interest to yourself as well. Failure to pay back any or all of the loan will result it in being treated as a taxable distribution. Therefore, whatever principle that has not been repaid will be taxed at your current rate when you file your taxes.
Should You Borrow from Your Solo 401(k)?
Under usual circumstances, it’s never a great idea to take money from your retirement plan(s). Of course, these times call for unusual actions. Borrowing from your 401(k) is a far better option than withdrawing. Obviously, you need a plan that will allow for this. There are two really good reasons to utilize the CARES Act and Solo 401(k) loan. First, no taxes are due. So long as you keep up with your payments, you won’t have to pay any taxes on the money borrowed. It should be noted that taxes on retirement plan distributions can be paid over three years. This is another provision of the CARES Act.
Secondly, if you do not want to pay taxes right now, you have the ability to repay the money to your plan. Studies show that when one takes a distribution from his or her retirement plan, the plan stops being funded. Obviously, the more money in the plan, the power power it has. A 10% return on $500,000 is much nicer than on $50,000! Remember, there are your retirement savings. If you want to retire some day, it’s important to allow the funds to grow unhindered.
During these difficult times, you may need to rely on the CARES Act and the Solo 401(k) loan. You should keep in mind that this is an extreme situation. Once everything returns to normal, you need to keep up with your retirement savings. Another important takeaway is having an emergency fund. Of course, you may have one and it just wasn’t enough.
If you have any questions about the CARES Act, the Solo 401(k) loan or anything else, please reach out to us @ 800.472.1043. Practice social distancing and Go Solo!