Self-Employed? SEP vs. Solo 401(k) (Part 2)

Solo 401(k) Participant Loans

There are many financial planners who look at 401(k) participant loans with disdain.  They may advise that a participant never take a loan from their 401(k) plan.  In fact, many participants themselves may not want to take out participant loans.

But, there is no doubt that the ability to access participant loans from a 401(k) plan is a powerful tool for many.  The issue may not be whether it is good or bad, but whether the participant has the discipline to repay the loan in compliance with IRS regulations.  One thing that no one can argue is that having the ability to access a loan from the plan is a potentially tremendous benefit of a 401(k), and certainly a benefit the SEP-IRA does not have.  Yes, you read that correctly.  The SEP-IRA, nor any IRA for that matter, allows loans.

In fact, a surprising fact to some is that even though a 401(k) participant can access a loan(s) from the plan, their ability to exercise participant loans must be permitted by the plan documents.  So, if the plan documents do not permit participant loans, then the participant cannot access a loan from the plan.  For example, a company’s 401(k) plan Trustees may not permit such loans if they believe there is too much administrative responsibilities in providing this option to its employees in the plan.  However, in the case of a Solo 401(k) plan this is not an administrative burden as the business owner and plan participant are one in the same.

IRS Rules?

For those interested in exercising the Solo 401(k) loan, the benefits are significant. The participant will be permitted to take loan(s) totaling up to $50,000 or 50% of the account’s balance, which is less. Of course the loan must be repaid based on IRS regulations, but the loan can be used for any reason whatsoever….it belongs to the participant. As noted, the SEP-IRA does not permit participant loans.  Now the question for you….IF the benefits of the SEP-IRA and the 401(k) were exactly the same with the only difference being that the 401(k) had the loan option and the SEP did not, wouldn’t that benefit, in and of itself, be the reason to elect the 401(k)?

I think we know the answer, but the truth is that the option for a plan loan is not the only reason for the 401(k).  We’ve now identified two benefits….higher contribution limits and loan provisions….and we will continue to identify more.  Quite candidly, these two benefits alone are the primary reason why a SEP-IRA candidate will and should elect the 401(k).  But, keep reading, as we will demonstrate additional benefits of the 401(k) vs. the SEP-IRA.

As always, the information is intended to be educational in nature.  It is not intended, nor should it be interpreted as, any form of tax, legal, financial or investment advice.  You must always consult with your respective professional in all such matters.