Self-Directed 401k Loan --Maximum Allowable Interest?
Real Estate Investor · Malvern, PA · Member since 2011 · 72 posts · 8 votes
I'm looking to take out a loan from my self-directed 401k, but I'm curious as to what interest rate to charge myself. I actually want to charge myself as much interest as possible since I'm not planning on contributing anything to the 401k this year. Anyone know if there is a maximum allowable interest rate and, if so, what it is?
Also, I have several different investments in my 401k in addition to cash. My plan documents state that I can borrow $50k or 1/2 of the vested balance, whichever is less. Does the vested balance include the value of my investments. Or, is it simply the amount of all of my contributions to the plan since its inception?
I was trying to find a way to loan myself from my SD IRA or a solo 401K a lot more than 50K.
These transactions can be made with yourself but with the use of LLC's and your Self-Directed IRA cannot under any circumstance become more than a 49% owner of any LLC, or business you invest in.
Here is an example of how this works.
If you own the current rental properties in an LLC and you are the 100% owner of the LLC you can legally sell 49% of the LLC company to your SD IRA and raise funds that way.
Since the SD IRA is set up FBO Bruce M. and the LLC is in place than the transaction that takes place is between the SD IRA and the LLC. However when you do this all costs of the rental properties and profits must be split accordingly between the SD IRA and the LLC.
Lastly a SD IRA is far superior than a Solo 401k because of the tax advantages on the back end being Tax Free.
Let me know if you have any other questions.
You can "partner" with your plan, but the rules and steps are complicated and if not done exactly right, you risk executing a prohibited transaction.
Lastly, a SDIRA is NOT far superior to a 401k plan "because the tax advantages on the back end being Tax Free." - as this statement is false. ONLY in a ROTH IRA are the back-end profits tax free and you can certainly set up a ROTh 401k. So, to be clear, there is no tax free profits in a self directed or traditional IRA UNLESS it is a Roth and 401k plans are far superior to IRA plans (both traditional and Roth) because the 401k offers borrowing provisions, offers larger contribution limits, and in some cases, avoids UBIT where the IRA would not. Clearly, the 401k option is the better of the two so if you have the ability to have a business without any employees other than your spouse, go for the roll over into a new solo 401k plan.
Good questions. I don't know the answer to either, but for the first one I would charge yourself what the market is paying. Anything else is likely going to raise IRS eyebrows in the unlikely event you are audited.
I would guess the answer to the 2nd question is the balance and not the contributed amount.
That makes sense, Bryan. In the SD 401k/IRA world, I think it's always best to lay things conservatively unless you're absolutely positive one way or the other.
Pertaining to the balance; what if one had, say, $100k cash and an active loan to a third party for $100k at 10%. Would you include the loan amount and the interest? Again, I think I'm play this conservatively, but I'd still like to know the answer for the future.
The vested balance refers to the balance of your account that you are entitled to after a period of time. For instance after one year you could be 50% vested meaning you are only entitled to half of the value of the account. You would more than likely need to contact your HR dept if the amount is not spelled out in your documents.
I thought loaning yourself or your LLC money from your self directed IRA was a disqualified transaction and you could not do it? Am I wrong? Can you loan yourself money form Self DIrected IRA for rental property in your name/LLC name?
Bruce M
We're talking solo Ks (or self-directed 401(k) funds)....not SDIRAs. This is one of the many reasons solo Ks are superior to SDIRAs.
It probably depends on what your plan docs say, but I am sure there are rules for this from the tax courts.
Ken Sanders - Your vested interest can only include money you have invested and does not count interest earned or company matches. So if you have only placed $25k of cash into your 401k, then (and only per the period of time mandated by your plan as Brian pointed out) your vested interest is only $25k (assuming the time period has happended).
As to the interest your 401k can charge you, that is limited by the usury limit of the State in which you live. Here in CA, the usury limit is 10% so that would be the max I could pay my 401k plan.
Bruce M - You are correct, you can not loan money to yourself from your self directed IRA, however, we are discussing 401k plans (self administered) and these plans have borrwoing provisions, which are one of several reasons why self directed 401k plans are better than SDIRA's.
Most 401k plans (both self directed and standard company provided plans) offer borrowing provisions and are limited to a max loan of $50k or 50% of your vested interest.
@ Ken, Rather than loaning money to yourself have you considered 1st trust deeds via Non-Recourse Loans. I know I many members that are looking for a better deal than what NASB offers and then someone else would be paying the interest, rather than you.
Will, Do you or does anyone else know if a self directed SEP/IRA can be rolled over or converted to a solo 401K? I have funds in a self directed SEP that I have been trying to figure out how I could loan my LLC money for properties I am buying or already own, since I am tapped out on getting any more financing. I did not realize that the solo 401K had different rules on lending to yourself versus the self directed SEP/IRA. I guess I did the SEP becuase they are simple to do, but now I am regretting it hearing all this. What are the annual contribution limits on a solo 401K and is it maxed out at 25% of total income (wages) like the SEP? Any response would really be appreciated.
@Bruce M I believe a solo 401K is just simply a 401K through a SD admisistrator, so the limits are the contribution amount of $17K or $22,500 if you are over 50 (due to the $5,500 catch-up). I have heard that once you roll a 401K into a IRA, that you cannot roll it back, due to the 401k is an employer plan, but maybe someone smarter can chime in to clarify.
In my case I am and always have been the employer so all my SEP/IRA money is mine from contributions for the last 15 years. I thought I read somewhere that the solo 401K may have had higher limits than the 401K (currently 17K you are right, if under 50 without catch up provsion). I hope others chime in on this as this is a hot spot for me. Thanks!
Bruce M, I found this on the web under a solo 401(k).
In 1981, the IRS formally described the rules for 401k Plans. The Solo 401k Plan is an IRS approved type of qualified plan. The Solo 401k plan” is not a new type of plan. It is a traditional 401k plan covering only one employee. The plans have the same rules and requirements as any other 401k plan. The surging interest in these Solo 401k plans is a result of the EGTRRA tax law change that became effective in 2002.
A Solo 401k plan is perfect for any sole proprietor, consultant, or independent contractor. A Solo 401(k) Plan offers the same abilities as a Self Directed IRA LLC, but without having to hire a custodian or create an LLC.
The Solo 40IK Solution
A Solo 401k Plan offers a self employed business owner the ability to use his or her retirement funds to make almost any type of investment, including real estate, tax liens, private businesses, precious metals, and foreign currency on their own without requiring custodian consent tax-free! In addition, a Solo 401k Plan will allow you to make high contributions (up to $55,500) as well as borrow up to $50,000 for any purpose.
Ken Sanders I am pretty certain you can borrow upto 1/2 of the value or $50k, which ever is less.
Bruce M, I found a Q&A on the web for a provider of solo 401k's. http://www.irafinancialgroup.com/whatissolo401k.php
How do I Initially fund the Solo 401K Plan?
"Like the Self-Directed IRA LLC, to initially fund the Solo 401(k) you may rollover funds from Traditional IRAs, SEP Plans, previous employer 401(k) plans, Money Purchase plans, Profit Sharing plans, Keogh plans, Defined Benefit plans, 403(b) plans and Rollover IRAs tax-free! This is accomplished by setting up a Trust account for the Solo 401(k) and directly transferring the funds from the current Custodian to the trust bank account. The trust account can be opened at any local bank or credit union."
What I don't see here is the ability to fund it from SD IRA plans, 408(a) or Roth SD IRA 408A(b), so it does not look like that once it is a SD IRA, that you can convert it to a Solo 401k, but I am far from an expert here.
Yes, you can roll-over a self directed IRA to a self administered 401k plan (solo k plan) IF you are self employed and do not have any employees other than your spouse. Combined with company matches, you can put in more than the $17k mentioned - I would have to look it up to refresh my memory on the exact amount.
Once you roll it over, you now have your solo k plan and you can make your loan provisions to anything you want for your plan up to the max which is the $50k or 50% vested interest. 401k loans are just that, loans from your 401k to you personally, but to pay it back, you must have your paycheck from your company deduct the payments from your income check. The interest you pay is determined when you set up your plan and can not exceed usury limits for your state.
Here is a really good blog entry on the basics of solo 401Ks right here on BP:
http://www.biggerpockets.com/blogs/2810/blog_posts/21298-advantages-of-self-directed-solo-401k
It answers some of the questions above.
Thanks for all the replies and info. The solo 401K loan would be a max of 50K though. That is just the same rule that employees have at any company.
I was trying to find a way to loan myself from my SD IRA or a solo 401K a lot more than 50K. I wanted to be able to fiance some of my rentals by paying interest back to my self directed retirement plan. Except for the max of 50K, I see no other options for doing this? If anyone knows different, please let me know. Obviously doing it with my SD IRA (to myself or my LLC) is a violation of IRS rules.
Bruce M a way would be to be a hard money lender to someone else. As a hard money lender, you pick the rate and term. Might be especially helpful if you can find someone else in a similar situation and would like to lower or increase your interest you are both receiving. As long as the rate you charge is not a sweetheart (less than prime rate. There should be no question from the IRS.) and you can charge pretty much as much as you want on the high end.
NASB for a Non-Recourse Loan is around 6.5%, with 2% origination, so many other SD IRA folks would be happy to pay less than 6% IMO.
Your best bet is to loan someone else money and make the interest on it for the retirement plan.
Bruce M. I have the answers you need.
I was trying to find a way to loan myself from my SD IRA or a solo 401K a lot more than 50K.
These transactions can be made with yourself but with the use of LLC's and your Self-Directed IRA cannot under any circumstance become more than a 49% owner of any LLC, or business you invest in.
Here is an example of how this works.
If you own the current rental properties in an LLC and you are the 100% owner of the LLC you can legally sell 49% of the LLC company to your SD IRA and raise funds that way.
Since the SD IRA is set up FBO Bruce M. and the LLC is in place than the transaction that takes place is between the SD IRA and the LLC. However when you do this all costs of the rental properties and profits must be split accordingly between the SD IRA and the LLC.
Lastly a SD IRA is far superior than a Solo 401k because of the tax advantages on the back end being Tax Free.
Let me know if you have any other questions.
@Michael Kowal I am not a tax professional, but I am pretty sure that your IRA of any sort cannot make a transaction with a disqualified person. A disqualified person is you or anyone that is a direct lineal descendant of the IRA Holder. Having a LLC in the middle of the transaction that you own, is still self-dealing. You cannot buy, sell or loan money to a disqualified person.
Who is a “Disqualified Person”?
The IRS has restricted certain transactions between the IRA and a "disqualified person". The rationale behind these rules was a congressional assumption that certain transactions between certain parties are inherently suspicious and should be disallowed.
The definition of a "disqualified person" (Internal Revenue Code Section 4975(e)(2)) extends into a variety of related party scenarios, but generally includes the IRA holder, any ancestors or lineal descendants of the IRA holder, and entities in which the IRA holder holds a controlling equity or management interest. In essence, under Code Section 4975, a "Disqualified Person" means:
A) A fiduciary (e.g., the IRA holder, participant, or person having authority over making IRA investments),
B) A person providing services to the plan (e.g., the trustee or custodian),
C) An employer, any of whose employees are covered by the plan (this generally is not applicable to IRAs but dos include the owner of a business that establishes a qualified retirement plan),
D)An employee organization any of whose members are covered by the Plan (this generally is not applicable to IRAs),
E) A 50 percent owner of C or D above,
F) A family member of A, B, C, or D above (family members include the fiduciary’s spouse, parents, grandparents, children, grandchildren, spouses of the fiduciary’s children and grandchildren (but not parents-in-law),
G) An entity (corporation, partnership, trust or estate) owned or controlled more than 50 percent by A, B, C, D, or E. Whether an entity is a disqualified person is determined by considering the indirect stockholdings/interest which would be taken into account under Code Sec. 267(c), except that members of a fiduciary's family are the family members under Code Sec. 4975(e)(6) (lineal descendants) for purposes of determining disqualified persons.
H) A 10 percent owner, officer, director, or highly compensated employee of C, D, E, or G,
I) A 10 percent or more partner or joint venturer of a person described in C, D, E, or G.
Note: brothers, sisters, aunts, uncles, cousins, step-brothers, step-sisters, and friends are NOT treated as “Disqualified Persons”.
Jim
I was trying to find a way to loan myself from my SD IRA or a solo 401K a lot more than 50K.
These transactions can be made with yourself but with the use of LLC's and your Self-Directed IRA cannot under any circumstance become more than a 49% owner of any LLC, or business you invest in.
Here is an example of how this works.
If you own the current rental properties in an LLC and you are the 100% owner of the LLC you can legally sell 49% of the LLC company to your SD IRA and raise funds that way.
Since the SD IRA is set up FBO Bruce M. and the LLC is in place than the transaction that takes place is between the SD IRA and the LLC. However when you do this all costs of the rental properties and profits must be split accordingly between the SD IRA and the LLC.
Lastly a SD IRA is far superior than a Solo 401k because of the tax advantages on the back end being Tax Free.
Let me know if you have any other questions.
You can "partner" with your plan, but the rules and steps are complicated and if not done exactly right, you risk executing a prohibited transaction.
Lastly, a SDIRA is NOT far superior to a 401k plan "because the tax advantages on the back end being Tax Free." - as this statement is false. ONLY in a ROTH IRA are the back-end profits tax free and you can certainly set up a ROTh 401k. So, to be clear, there is no tax free profits in a self directed or traditional IRA UNLESS it is a Roth and 401k plans are far superior to IRA plans (both traditional and Roth) because the 401k offers borrowing provisions, offers larger contribution limits, and in some cases, avoids UBIT where the IRA would not. Clearly, the 401k option is the better of the two so if you have the ability to have a business without any employees other than your spouse, go for the roll over into a new solo 401k plan.
Will Barnard is correct.
I represent taxpayers before the IRS. In other words it is my job to make sure my clients don't go to jail.
Do NOT take Michael K.'s advice there. It is entirely incorrect and WILL cause you to have to your IRA fully distributed and to pay tax on the ENTIRE early withdrawal.
Solo 401ks are FAR superior. This is especially true when you add the Roth provision.
You can partner with your IRA; however, your IRA cannot BUY into a business that you own. It MUST be a newly formed entity.
-Steven
Steven Hamilton II Will Barnard
I know you guys are refering to 401K's here but is it possible to use the funds in my 403(b) to invest in real estate or roll it into something such as the solo 401K that can be used? I currently use all traditional financing so even if it's a loan to myself (LLC in my husbands name) it seems like atleast I would collect the interest instead of the bank. If I can do this who do I contact to get it set up and would it work better for flips or buy and hold? Any ideas would be appriciated. Thanks!
Jodi Melssen,
The only way to utilize those funds would be to take a loan from the account through your employer. Otherwise you would have to roll over to a solo 401k and invest through your own C-Corporation. You could then pay yourself a salary and borrow from that solo 401k. But it must be an actual business that you are running. Many do not look at the significant benefits that C-corporations offer.
-Steven
Jodi Melssen Discuss with your current plan administrator whether it's feasible to roll any of your qualified plan money out to a self-directed vehicle.
The solo 401K is the best overall choice. But bear in mind that the solo 401K does require a sponsoring business. And that needs to be an active business that reports active business income on a Sch. C or the equivalent (i.e. pays self-employment taxes). Owning rental property does not qualify by itself, as this is investment income, not active business income. Being a real estate agent DOES qualify, as well as flipping, wholesaling, etc., of course.
There is no minimum level of business activity specified in the code, but if the business does no activity in a given year, then the 401K is supposed to terminate and transfer to an IRA for non-self employed folks.
If you meet the criteria, the solo K is clearly better than the SD IRA/LLC (or checkbook IRA). I just set one up for a mere$400, it has minimal annual reporting requirements/fees, has very generous contribution limits, and allows you to borrow up to $50K that can be used for whatever purpose you like (just like the big company 401K plans). This latter feature is what sold me, and so I set one up to transfer an old employer 401K account.
You simply open a depository account with your local bank. You are the trustee, make all investment decisions (obviously watch for prohibited transactions), can invest in the full range of alternative assets, and directly write all checks and collect all receipts. Absolutely no custodian needed, just the plan administration company that sets it up and handles the minimal annual reporting. If the account is less than $250K in size, there is no annual IRS reporting. If larger, just complete Form 5500, not complicated.