Investing Your Solo 401K in Notes & Trust Deeds [Illustration]

For many years, large Fortune 500 companies have sought higher investment returns for their Pensions and 401K Plans through Promissory Notes and Deeds.  If you have a Solo 401K you have the same access, just like any other company.

This investment type is easy to execute, straight-forward, and profitable.  As Trustee of the Solo 401K, you have the control of the terms, including maturity date of the loan and the interest rate. The first step is selecting a solo 401k provider.

Promissory Note Defined

A Promissory Note:

Looking to Get $100,000+ Into Retirement?

We'll show you the #1 tax and retirement strategy!

  • It is simply a promise to repay a loan
  • It is a Legal Document
  • It includes the stated interest rate and loan duration

If your Solo 401K includes a promissory note and that note goes into default (the borrower cannot repay the loan), then the Solo 401K can take control of the property, or foreclose on the property, just like a bank would.

Promissory Note Terms

The promissory note terms typically include the following:

  • The specified interest rate for the note
  • The length or duration of the note (when it would be paid-in-full)
  • The amount of the Loan, how much the Solo 401K will receive

These variables determine the value of the loan.  Much like a bank lending money for a home (a mortgage), the value is also measured by the ability of the lender to repay the loan in-full.  Obviously, defaulting on the loan is not the desired outcome.

Promissory Note Loan-to-Value (LTV) Ratio

Again, much like a bank would, your Solo 401K should first know the value of the property being used as collateral for the loan.  One thing that is important is what is known as the Loan-to-Value Ratio or LTV.  A lower real estate LTV is better.  The wider the gap between what is being borrowed and the value of the property is better.

Which is better?  You have a property value of $50,000 and the loan could be either $15,000 or $35,000.  A loan of $15,000 would have a LTV of just 30 percent, whereas the $35,000.00 loan would have a higher LTV of 70 percent.  The 30 percent LTV is a much safer investment.  The equity is much higher for the borrower, which means they also have more to lose and are more likely to not default on the loan.

Promissory Note or Trust Deed Interest Rates

One of the first decisions you need to make is to set the type of interest rate for the loan.  Typically, it will be either Compound or Simple interest.  Simple interest is straight-forward.  If your Solo 401K made a loan in the amount of $10,000 and charged 4 percent, at the year-end you would receive $400.00 in interest, plus the original $10,000 or $10,400.

Solo 401K Promissory Notes and Trust Deeds

With compound interest not only do you pay the interest on the principle amount (the amount borrowed), you pay interest on the interest that is accumulating.  If you made the loan for $1,000 and charged 5 percent compounded monthly, at the end-of-the month you would receive $1,050.00 after the first month, $1,102.50 the 2nd month, etc.  The first month you would charge $50.00 in interest, then in month two $52.50.  Here is a better illustration:

Month One    $1,000.00 X 5 percent = $50.00, or $1,050.00

Month Two    $1,050.00 X 5 percent = $52.50, or $1,102.50

Promissory Note Types

There are two types; Secured and Unsecured

  • A secured note essentially means there is collateral in place, making this the safer of the two. The collateral is usually something like equipment or real estate.  Again, going back to a bank, a mortgage, and a home, if the borrower cannot or will not make payments, the Solo 401K will take possession of the collateral item.  The idea is to make the lender whole.
  • An Unsecured loan adds risk. Typically, if your Solo 401K makes such a loan, it will want to charge a higher interest rate since there is no collateral, nothing of value to receive if payments are not made.  Usually the only recourse is via the legal system in hopes of recovering your money.

Solo 401K Promissory Note – Trust Deed Investment Processing

  • Once the note has been established, be sure to fully review it to ensure it complies with all regulations and that it adheres to your Solo 401K rules. Consulting with a professional is recommended
  • It is very important that it reflects your Solo 401K as the lender
  • As Trustee of your Solo 401K, sign all necessary papers
  • Use only funds from your Solo 401K checking account
  • Once payments are made, all deposits will go into your Solo 401K checking account, thus payments will be made out to the Solo 401K

Solo 401k Promissory Note Frequently Asked Questions (FAQ)

Can a Promissory Note be written to my LLC by my Solo 401K?

Unfortunately, you cannot, as it would be considered a prohibitive transaction.  Promissory notes are not allowed for a business you own.

Since I can obtain better financing than I could through my Solo 401K, would I be able to get an interest only/balloon loan to myself for use as a down payment for a real estate investment?

Rules do not permit that arrangement.  However, there is something called a Solo 401K Participant Loan, and that would be a viable option for you.

Would I be able to be a partner with my Solo 401K for a Promissory Note Investment?

I will elaborate:  Here is what I would like to do with this arrangement. I would like to make a $200,000.00 real estate loan to a third-party and I would like $50,000.00 to come from my Solo 401K and the remainder, or $150,000.00, to come from me.  The documents would reflect that I own a 75 percent interest in the loan and my Solo 401K owns the remaining 25 percent of the loan.

I would send a wire for $150,000 from my personal checking account to the Title Company while my Solo 401K would wire the remaining $50,000 to the Title Company. Then, the borrower would make two payments each month, one to me directly and one to my Solo 401K.

It is possibly, but one thing is a must; the borrow cannot be a disqualified person.  In addition, you or any disqualified person are NOT permitted to be a director, an officer, or an employee of the company joining the Solo 401K Promissory Note Investment.  You will also want to document separately each of the promissory note investments and not as pooled notes.  This is because you will hold a promissory note with the same borrower.

Does the Solo 401K Custodian assist with an Unsecured Solo 401K Promissory Note?

The primary role of a custodian is to serve as custodian of the cash in the Solo 401K.  They do not hold alternative investments, prepare any promissory note documents, answer Self-directed Solo 401K questions, or even any reporting activity.  A Solo 401K provider would assist with answers to questions and reporting.  Either you, or an Attorney will need to create the promissory note document, since you are the Trustee of the Solo 401K.

It is okay for the borrower to pay and this tends to be the norm.

If I invest $50,000 in a Promissory Note paying 8 percent interest and I then receive a 1099-INT in the amount of $4,000, does the Solo 401K pay any tax due on the $4,000?

Since the Solo 401K is a tax-sheltered investment, any Promissory Note payments continue to be tax-deferred, and taxes are not due or paid until a distribution is made. Any interest earned on a Promissory Note Investment does not incur Unrelated Business Income Tax (UBIT).

If my Solo 401K does a hard-money loan and points are paid, is that considered a gain?

It would and that gain would be tax-deferred while in the Solo 401K.

Clearly there are many advantages to solo 401ks. On of the most important is the opportunity to invest in alternative assets like promissory notes and trust deeds.

Paul Sundin

Get a FREE 30 Minute Consultation

Reach out to us today and we'll show you our favorite strategies! We can show you how to structure a plan for maximum tax benefit and provide you with a custom plan design.

Leave a Comment