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Funding Your Solo 401k With A Loan

If you are self-employed or a sole proprietor, such as a moonlighting per diem healthcare professional, you have the option to contribute to a solo 401k. IRS rules require that you do so before the tax deadline on April 15th.

However, you must establish the account before the end of the calendar year, December 31st. Even if you don’t put a dime in there, it has to be opened with your broker of choice by that date.

In this post I’ll discuss a scenario where you may not have had enough money to max out your solo 401k and would need to resort to taking out a loan. How much would you save in taxes by making the contribution in time and would the lending fees be justified?

Summary for the lazy:

If you earn a gross of $100k and deduct $20k of expenses then by contributing to a solo 401k you will save $6,120. So if it cost you $700 to take out a loan to fund that $18k of a 401k, you’ll still be ahead. 

There, happy? Now you don’t have to read my long-ass post, you lazy %@#$^. Let me know if you like summaries up front from now on in the comments below. And also if you’d like for me to chew your food for you or walk your dog. 


Types Of 401k’s

The most common 401k’s we as healthcare professionals are familiar with are the ones offered to us by our employers. As of 2017, we can set aside $18,000 from our paychecks into such an account. Sometimes, our employer will even match this.

There are other kinds of 401k as well, such as a solo 401k or also called an individual 401k. These are established by the sole proprietor (per diem clinician) or business owner for themselves instead of for employees.

The Solo 401k works very similar to your employer-sponsored 401k program. You can contribute up to $18,000 in 2017 and there is even a 20% “employer” contribution. I’ve written about this in another post.

I won’t discuss a Roth 401k here because it isn’t beneficial for most healthcare professionals.


The 401k Tax Deduction

Imagine you transition down to a per diem from your full-time job and now you are earning income as an independent contractor.

An IC is paid on a form called a 1099-MISC and hence the term “a 1099 worker” or “Miscellaneous Income”.

Especially that first year when you transition to a per diem, you won’t have all your finances in order. You likely won’t have a separate account for your estimated taxes and you won’t be funding your solo 401k with each paycheck.

But you also don’t want to be missing out on that sweet, sweet tax deduction.

Taxes on $100k Gross Income

What does it actually look like to have a 401k deduction on your taxes? It took me a long time to understand the actual numbers behind the tax benefits of contributing to a 401k.

If you earned $100k as a moonlighting sole proprietor and had $20k in expenses that you wrote off against that income on your schedule C form, such as travel, meals, licenses, and equipment, then you’ll be left with a net income of $80,000.


This $80k would be taxed by the following entities, for a total tax burden of $32,145:

  • Federal ($13,139)
  • State ($6,766)
  • Medicare ($2,320)
  • Social Security ($9,920)




Taxes With 401k Contribution

So with $100k gross income your taxes would be $32,145, leaving you with $47,855 of net take-home income.

Now let’s assume that you also contributed $18,000 to your 401k. How would this affect your tax burden?

Your 401k contribution will be excluded from federal + state income taxes but will still be subject to self-employment taxes (Social Security + Medicare).

You would subtract the $18,000 from the $80k and you’d be left with $62,000, off of which your income taxes (federal + state) would be calculated. While your self-employment taxes would be based off of the $80,000 for a total tax burden of $26,025:

  • Federal ($8,639)
  • State ($5,146)
  • Medicare ($2,320)
  • Social Security ($9,920)

In both of these scenarios your income ($80k) and business expenses ($20k) stayed the same. The difference is that you sheltered more money from taxation. This allowed your net worth to go up by $6,120.


Taking A Loan To Fund Your Solo 401k

Knowing that if you contribute to your solo 401k you’d be left with $6,120 more for the year, it’s easier deciding whether it would be worthwhile to take out a loan to fund that $18,000 along with its associated loan expenses.

Cash Advance From Credit Card

I can get an $18,000 cash advance from my credit card for a $700 fee and 0% interest for a little over a year.

I will then contribute that $18,000 to my 401k and invest the money. The point of contention isn’t whether my $18k will earn enough to make up for that $700 fee but if my tax-savings will offset the loan expenses.

I would be losing out on $6,120 for sure if I didn’t contribute that $18k. So $700 is a drop in a bucket compared to that. In my mind the math makes sense to take the cash advance. What do you think?

Writing Off The Loan Fees

Because I’m a sole proprietor, I can deduct the loan fees on my taxes. It’s still money that I would lose out on but at least I wouldn’t be taxed on that money – it’s like paying for the loan-fees with pre-tax dollars.

When I refer to ‘loan-fees’, that also includes any interest charged on the borrowed sum.


File An Extension

Your alternative option, if you don’t want to take out a loan, is to file an extension until October 15th.

This would extend the time you have to max out your 401k for the previous year. Once again, keep in mind that the account must have been established before the end of the previous calendar year.


Factors To Consider

Protection against debtors. If you take out a credit card loan or a personal loan and you fall on hard times, it’s easier to dismiss that or negotiate a better rate on it. But by contributing money to a 401k you will have money that’s protected from creditors in most states.

Do you need more retirement accounts? If you already have a healthy tax-deferred retirement account then it may not be worthwhile to contribute more money to that account. Consider saving and investing your money in a private brokerage which will be easier to access.

Don’t forget the IRA option. If you’re not covered by a work retirement plan then regardless of how much you earned as an independent contractor, you can contribute the annual maximum ($5,500 currently) to a traditional IRA and take a tax deduction for it. This might serve you well in case you don’t want to establish a solo 401k.

Will you be able to pay the $18k back in time? If you lose your main income source (like I did a few months ago) or decide to cut back on work then you’ll have yet another debt burden to tackle. The idea of having debt yet again may not be worth the money you’ll save by maxing out your solo 401k.

Your 401k would grow tax-free… but investments don’t alway grow. The discussion gets more complicated because you are taking this $18k and assuming it will earn you a positive return in your investments. The advantage that you will have is that this 401k investment will grow tax-free (if it does grow) and only get taxed once you withdraw the money.

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