It is indeed possible to source some much needed cash from your retirement plan. Many employers offer retirement plans which allow their employees to take out loans from their accounts. There are however, some IRS rules that must be observed with regards to the issue.
For plans that allow loans, repayment must be fully completed within five years except for instances where the loan was meant to facilitate the purchase of a home. For home loans there isn’t a specified time limit but the loan must facilitate sizeable amortizations with payments being made at least quarterly.
There also are dollar limits to contend with. Loans should generally not surpass the lesser of $50,000 or half the current value of an employee’s vested amount in the plan. Retirement plan loans that don’t meet these criteria are treated as distributions to borrowers. Those kinds of distributions are generally subject to taxation and an extra 10% penalty for those under 59½ years old, unless there is another applicable exception.
1About
Prior to taking a loan from your retirement plan, you should seek the counsel of a credible financial planner who will either consent that this is the best option for you or object to it and advise you on alternative loan sources. The following pointers are some of the factors which must be considered:
- Purpose of the loan – The financial planner may approve of the use of a loan for purposes of paying off high-interest credit card debts. This is more so where the credit balances are much higher than the potential repayment amounts of the loan from your retirement plan loan. Using such a loan for leisure purposes is financially ill-advised.
- Cost of the loan – The advantage of borrowing from your retirement plan is that repaid loan interest amounts are remitted into your qualified loan account. That said, it is imperative for you to compare the interest rates set for a retirement plan loan and those set for financial institution loans to find out which is higher and if the difference is significant.
In terms of the disadvantage, assets that are taken away from your retirement plan as a loan become exempt from the gains of tax-deferred growth on earnings. Also, the monies used for loan repayment are obtained from after-tax assets, effectively meaning that taxes have already been paid on those amounts. These repayment amounts are therefore not tax deferred.
- Effects of taking the loan – If your 401k requires you to postpone elective-deferral contributions for a determined period after getting a loan, you will want to think about the consequence of this delayed opportunity to fund your retirement plan.
2Rules Governing Qualified-Plan Loans
The first thing to do when you need to borrow a loan from your retirement plan is to inquire from your plan administrator or employer as to whether this is possible. While doing so, it is vital to establish whether there are any loan restrictions because there are plans which only allow loans for hardship circumstance purposes like home evictions due to non payment, medical expenses, or expenses for higher education. For such loans, you are generally required to have failed to secure monies from any other alternative sources.
Some retirement plans are however very lenient and attach no such restrictions – borrowing can be done for any reason and without the need for purpose disclosure.
3Maximum Amounts That Can Be Borrowed
One of the regulations that a qualified plan must operate by has to do with loan amount restrictions. The maximum amount that can be obtained as loan is either 50 percent of one’s vested balance or $50,000, whichever is less. There are exceptions to this limit if 50 percent of your vested balance is below $10,000; the maximum that can be borrowed in this case is $10,000. Not all plans make this allowance though.
4Documentation Requirements
It is possible that your employer will have special forms that you must complete before taking out a loan from your retirement plan. You should therefore inquire from your plan administrator or employer about this.
5The Pros of Borrowing From Your 401k
Taking a loan against your retirement plan does not require a credit check and you don’t need to make an application for the loan. You can therefore make your plans with the assurance that you’ll get the funds.
- These loans have a low interest rate – this rate is in most cases a few percentage points higher than the prime rate.
- There are great returns to be obtained. If for instance your money market account earning rate is 3%, and you are paying yourself back in the order of say 6% or 7%, this makes for a good deal.
- The interest is sheltered against taxation – you need not pay taxes on the accumulating interest until your retirement age when you claim money from the plan.
- Borrowing from these plans is highly convenient – all that you need to do in some cases is make a phone call or just fill out some brief forms.
