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Solo 401(k) Plan Loan


Catch22PGM
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Husband/wife solo-401(k) plan.  They were not using a TPA, have self-directed brokerage accounts, and used a loan recordkeeping system to take out 4 loans back in 2019 - 2 for each of them.  As a TPA I have never dealt with this loan recordkeeping system so I don't know the whole story, but it allowed 2 of the loans to be taken with a 1% interest rate.  Not Prime + 1% - just a flat 1%.  The other two loans had Prime + 1% applied.

Their financial advisors wised-up and brought them to your friendly local TPA.  There are numerous other issues with these loans that we will help them fix through re-amortizing and consolidating.  My questions for the BenefitsLink community:

1.  Is there any possible way that a 1% interest rate would be a "reasonable interest rate" for a solo-401(k) loan in the eyes of the IRS?

2.  Does anyone know how to shut down these loan recordkeeping systems when their services are no longer needed?  They send monthly "invoices" for the repayments (which have been wrong - long story) and they charge a monthly fee that we need to end.  I don't want to mention a name because I think they have botched these loans, but again, I don't know both sides of the story.

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On 7/25/2021 at 9:48 AM, Catch22PGM said:

1.  Is there any possible way that a 1% interest rate would be a "reasonable interest rate" for a solo-401(k) loan in the eyes of the IRS?

 

If you could show it was a commercially available loan rate at the time. Otherwise it would probably be deemed an unreasonable rate of interest.

As an example, perhaps if they had an offer for 0.9% financing on a new car loan but instead chose to borrow the money from the Plan for 1% instead the IRS might view that as a reasonable rate of interest.

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I would generally agree with Lou S. Here, the methodology for the loan is important. If the usual rate ever used by the plan was prime +1, then I would have a problem with a loan charging a 1% interest rate. I know that prime is very low, but if it were done on the prime plus 1 basis before, it still would be tough to justify the change to a mere 1%. I am also aware that if the plan had other participants and charged them prime plus 1 while allowing the owners to pay a mere 1$, there would at least be a problem with discrimination in benefits, rights and features in addition to the loan being treated as a prohibited transaction and currently taxable under Code Section 72(p).

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On 7/25/2021 at 12:48 PM, Catch22PGM said:

2.  Does anyone know how to shut down these loan recordkeeping systems when their services are no longer needed? 

They should consult the service agreement they have with the service.  And/or they should consult with their attorney how to accomplish the severance of service.

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Thank you all for the input.  As the commercials always say, "0% financing with good credit on certain models" can usually be found for a car loan but I see no way the IRS would accept that as an argument to allow a 0% 401(k) loan - maybe I'm wrong.  Two loans were taken at Prime + 1% exactly one month prior to the loans taken at 1% so even if that would be a decent argument, I'm hesitant to tell the plan sponsor that the 1% was reasonable and doesn't need to be corrected.

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Of course there should be a loan policy in place, so either they didn't have one, which is a problem, or they didn't follow it, which is a different problem.  Too many people without a clue doing plan stuff, sigh.

As far as getting their "system" to stop sending reminders and charging fees, it might be possible to just tell them the loans are paid off.  Of course when they get loan payments the system will freak out and try to treat them as contributions, so I don't know.  Best solution is to move the money elsewhere, but I get it, clients are strangely loyal to their brokers even when they prove their incompetence.

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