Thursday, 15 December 2011
Taking Loans from Employer-Sponsored Retirement Plans
If you participate in an employer-sponsored retirement plan that allows loans, you may be able to borrow from your vested balance in the plan. A plan loan can be an attractive way to meet expenses or pay off high-interest debts, but you should be familiar with both the pros and the cons before taking a loan.
Requirements
- You must participate in an employer-sponsored retirement plan that allows participants to take loans
- You must have an adequate vested balance in the plan
- You must not be classified as an owner-employee with respect to the plan (unless the plan has been amended)
- Plan loans generally must be repaid at least quarterly, usually over no more than a five-year period (unless for the purchase of a principal residence)
Plan Loan Limits
The IRS generally allows you to borrow from a qualified plan the lesser of:
- $50,000 (reduced by the excess of the highest outstanding loan balance during the one-year period ending on the day the loan is made over the outstanding balance on the date of the new loan), or
- The greater of $10,000 or one-half of the present value of your vested accrued plan benefits
Advantages
- Qualification is easy (often automatic)
- Interest rates are usually favorable
- The interest you pay usually goes into your own account
- The interest you pay may be tax deductible (if proceeds are used to purchase a principal residence)
Disadvantages
- Like all loans, a loan from your plan must be repaid
- Failure to make timely payments can result in the loan being reclassified as a taxable distribution for income tax purposes, and resulting in a 10 percent federal premature withdrawal penalty if done prior to age 59½ (your after-tax contributions, including any Roth 401(k) or Roth 403(b) contributions, are not taxed)
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- You pay tax twice on the funds you use to pay interest on the loan
- Plan loans have an "opportunity cost"
The Loan Process
- Consult your plan administrator for availability and procedures
