“I can’t get my business moving forward without capital and I can’t get capital without having an established (and solvent) business.” This is a vicious circle that many budding business owners face.

Getting traditional financing from a bank, such as a small business loan, requires the business to have revenue, prior tax returns, and/or established credit history. If the business owner doesn’t meet the bank’s minimum requirements, they are left to utilize alternative sources like personal savings, credit cards, borrow from friends and family, bring on investors and dilute equity, or pull equity from their home in order to pump capital into their business. Even if one or more of these options are viable, they may not be in the business owner’s best interest.

Solopreneur getting funding from Self-Directed Solo 401(k)s

The good news is, if the business owner has an old 401(k) or traditional IRA (among a few other types of pre-tax retirement accounts) and no W-2 employees working more than 1,000 hours per year (other than themselves, their spouse, or business partner) there could be another way to get a loan with no external application, no underwriting, and no indebtedness to another person or financial institution.

Another way

Nonemployer business owners and independent contractors who earn income from self-employment are generally eligible (per controlled group rules) to adopt a Self-Directed Solo 401(k)s retirement plan, which is designed specifically for them.

Self-Directed Solo 401(k)s not only help the solopreneur: 1) save money on their income taxes though salary deferral and profit-sharing contributions, 2) have the option to make Roth and Voluntary-After-Tax contributions, and 3) invest in traditional and alternative asset classes, such as real estate, though self-direction, but they also 4) have a loan feature.

Unfortunately, IRAs and most traditional 401(k)s do not allow for the account funds to be withdrawn without incurring taxes or being subject to an early withdrawal penalty if the person is less than 59 ½ years of age. This is why the solopreneur would want to adopt the Self-Directed Solo 401(k) and then roll their old 401(k) or pre-tax IRA (among other allowable pre-tax retirement accounts) into the Self-Directed Solo 401(k) account. This not only increases their investable funds for asset class diversification, but it also increases the amount of money that they can withdraw as a loan, especially if the plan is new and contributions in the plan are still low.

4 Characteristics of the loan feature

The key points to understand about the loan feature include:

  1. The account holder can take out a loan up to $50,000 or 50% of the account balance, whichever is less.
  2. Loans against the account are not subject to tax or penalty.
  3. The money can be used for anything without restriction, such as supplementing income, covering business expenses, paying down debt… the sky is the limit.
  4. Repayment terms apply: Interest is owed, generally Prime + 1%. It must be paid back to the account with no less than quarterly amortized payments within five years. However, if the loan is used for the purchase of their primary residence, they have 15 years to pay it back. If payments are not made, tax and penalties may apply.

Many people have an aversion to being in debt. Even though this is a loan that needs to be repaid, it’s a loan that the solopreneur can take from themselves (via their retirement account) instead of being in debt to another person or financial institution. What’s even better, the interest that the loan is incurring goes back into the account increasing their retirement funds.

For tax purposes, if the loan is being used for their business directly, they can expense the interest and treat it the same as if they were paying interest to a bank for a business loan.

Taking business loans

The difference maker

Imagine the difference that accessing retirement funds could make. If the solopreneur is just starting out and needs to supplement their income, the loan could buy them valuable time while the business ramps up.

If they have been in business for a while and times are tough, it could mean the difference between paying bills and putting food on the table, laying off a part-time employee or independent contractor, being able to acquire much-needed inventory and supplies, or going under completely. If the solopreneur needs to qualify for a large loan at a bank but has too much high-interest credit card debt, for example, they can use this loan to pay off/down their debt which will improve their debt-to-income ratio and credit rating.

Unparalleled advantage

Solopreneurs who access their own retirement funds have an unparalleled advantage. Since the money isn’t coming from an outside source, they don’t need to fill out an application, go through underwriting, have their credit checked, have their income and collateral scrutinized, give up equity, etc.

The solopreneur acts as the plan administrator and trustee, so they approve and manage their own loan. It’s the loan option that Self-Directed Solo 401(k)-eligible solopreneurs can obtain without the risk of being denied.