A self-directed 401(k) is a great way to save for retirement. Unlike the typical 401(k) plan set up by an employer, a self-directed one allows for a much more diverse investment portfolio. A self-directed 401(k) also grants you more control over your investment decisions. In fact, because it is self-directed, you have total control. This even includes the ability to make self-directed 401(k) loans to yourself.
As a self-directed 401(k) owner, you are allowed to borrow from your account. This is not permitted in almost all other types of retirement accounts. The Internal Revenue Service (IRS) distinguishes between taking a loan from your self-directed 401(k) and requesting a distribution. Early distributions can cause your entire individual retirement account (IRA) to be disqualified and subject to penalties and taxes. This is not so with a self-directed 401(k) loan. If you need a personal loan, for anything, the self-directed 401(k) is your best bet. Let us look at the two most frequently asked questions about how this works below.
You can borrow up to $50,000 or half of your balance, whichever is lower. In other words, if you have $75,000 in your account, you can only borrow up to $37,500; but if you have $150,000 in your account, the loan is capped at $50,000. Unlike a bank loan, borrowing from your self-directed 401(k) does not require a credit check.
Borrowing from your self-directed 401(k) works like any loan. In other words—and here's the bad news—you must repay it. If you are on a regular pay cycle, you can elect to make blended payments. These will consist of the principal and interest owed on the loan, as dictated by an amortization table. If you do not receive a regular paycheck, you must make a payment every 90 days. You have 5 years to pay back your loan. After that, the remaining balance of the loan is deemed to be a taxable distribution by the IRS. (There is a caveat if you are borrowing for the construction of your home. If you did, speak with a financial expert to determine if you are eligible for a longer repayment period.)
We have many years of experience helping our clients understand the IRS regulations placed on self-directed accounts. While these types of accounts give you total control over your future finances, we are here to ensure you do not trip over regulations that can cost you in penalties and fees. If you are considering taking a loan out of your 401(k), our experts advisors can help you plan your repayment options.
Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.
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