Solo 401(k) Gives Startup A Loan Source

• AUSTIN KILHAM for the Wall St Journal writes:  
At 54, the client left his job and six-figure salary at a large professional services company. He wanted to start his own business in the same sector, but wasn't sure he had all the capital he would need to get established.

As something of a last resort, he thought he might tap some of the nearly $1 million he had saved in a 401(k) and then rolled over into an individual retirement account. He turned to his long-time financial planner, Christopher Kimball, who manages $65 million for 120 clients at CK Financial Services in Lakewood, Wash.

"It's scary to leave an established company and strike out on your own, so I wanted to make sure he knew what his options were," says Mr. Kimball, who recounted the story. "Even if he had to dip into retirement savings I wanted him to access money without IRS penalties or income tax."

Because the client wasn't yet 59 1/2, he would face a 10% penalty on top of income tax for direct withdrawals from the IRA. So Mr. Kimball suggested creating a new one-participant 401(k) plan, also known as a Solo 401(k) or Uni-k plan, and then rolling a portion of the IRA assets into it. The accounts let participants borrow up to 50% of their funds, up to $50,000, as long as the loans are paid back with interest within five years.

Mr. Kimball recommended funding the new IRA with $100,000 from his IRA. That way, the client would have access to the maximum loan amount should he need it. He advised his client to leave the remaining $900,000 in the IRA, where he could pay the 10% penalty to withdraw additional funds should he need more than the $50,000 borrowed from his 401(k).

If the client ended up not needing a loan from his 401(k), the $100,000 would simply continue to grow tax-free until his retirement. That flexibility was especially appealing to the client, who had been concerned about his options for financing a business while still protecting his long-term financial security. "Finding capital and enough cash flow to start a business is nerve-racking," says Mr. Kimball.

Ultimately, it turned out that the client's business was profitable from the beginning and he didn't need money from his new 401(k). But he was happy to have had a safety net.

Mr. Kimball says the bottom line is that most clients aren't familiar with retirement account tax law and can miss a lot of money-saving opportunities. "That's why it's important that advisers are aware of these tax provisions," he says, "because it helps clients maximize the money in their pocket."