Solo 401k Loan Wizardry?

[Kyle McCorkel]

I just got done with the process of setting up, and rolling over funds into, a solo 401k plan for both me and my wife. My original intent was to have the funds available for us to do a personal 401k loan to ourselves, as potential funding for acquiring more deals and/or funding rehabs. The intention would be using this as short term financing until longer term financing can be put in place (BRRRR or flips). My concern with the 401k loans to yourself, however, is the amortization of the 401k loan is really short (5 years) making the monthly payments quite high, EVEN THOUGH the interest rate is low (prime plus one = 4.75% currently). Here's the comparisons I'm making:

• Monthly payment on $50K 401k personal loan (5 yr. amort @4.75%) = $937
• Monthly payment on $50K hard money loan (interest only @12%) = $500

The 401k loan payment is nearly DOUBLE the hard money payment.  Not attractive.  YES, I get that with the 401k loan you are paying yourself back, etc. etc.  But we are all (mostly) looking for cash flow NOW, right?

So, this brings me to my idea, knowing the following:

• You can privately loan money out of your solo 401k as long as it is not to disqualified person (family)
• You can't do a "roundabout transaction"; i.e. you can't loan to your friend who then creates another loan with the same money back to you

So, what if I know someone (who I met through Bigger Pockets...he is reading this post!) who is in a similar life situation as me.  Same age as me, and is starting to grow his real estate portfolio and looking for funding.  Who ALSO has a lot of money tied up in his 401k.  What if we shook hands and agreed to the following (some specifics can be modified):

• I fund his deals out of my 401k, and he funds my deals out of HIS 401k
• We offer each other identical terms and the same amount of money (say, $50K)
• Private, secured notes by the real estate that is being improved
• We should probably both do our due diligence on each other's deals, to make sure there is sufficient equity to get paid back on our loans
• Terms such as: interest only, 6%, one year balloon, to be re-paid upon sale or re-finance of the property, with option to extend/re-finance after one year (in case the unexpected happens).  No pre-payment penalty of course.  No points.
• Each of us rinses and repeats as much as we want, until one of us is no longer interested in the arrangement
• Monthly payment on $50K private loan (interest only @6%) = $250

Major benefits being we get to control the terms of the financing (vs. the strict 401k personal loan guidelines) and can avoid the taxes and penalties involved in completely withdrawing from our 401k's.  And of course the much lower monthly payment.

Obviously, the first thing I'm looking for from the BP community is if this is an acceptable arrangement to the IRS.  If so, has anybody else out there tried anything like this, and do you have any advice or pitfalls to avoid? How can we ensure that we are both protected, etc.?

[Dmitriy Fomichenko]

@Mindy Jensen thanks for the mention and bringing me into the conversation!

@Kyle McCorkel, you have to remember that you can't receive any direct or indirect benefit from your 401k. And it seems to me that by making such reciprocating loans to each other there is an indirect benefit to you personally. The IRS would have to make the final judgement call but do you really want to go that route? If you need a personal loan I would suggest to keep looking, it is possible to find cheaper money than 12%. Do you know some family members or friends who have money in a money market account making less than 1%? If you offer them in investment in a form of a loan to you secured by real estate and guarantee them 6 or 8% do you think it will be attractive to them? 

I know some people are using their 401k loans to fund their own deals (remember there is a limit how often you can borrow from your 401k), that is really not the purpose of the 401k loan. And you should be maximizing those funds to grow your wealth in a tax deferred manner instead of using it to help you grow your taxable wealth. You should continue with both strategies and use them independent of each other to grow your total wealth. 

I am like Mindy using my retirement funds mainly as private bank to lend to others and all that interest income is totally sheltered, you should do the same.