Marcus L. from Rhode Island asks, "Can I borrow money from my Retirement Account?"
Pension Evaluators & QDROS Of Troyan, Inc Associates Group answers, "An option some plans provide is a participant loan provision. This
provision allows participants to borrow against their account balances.
Some plans only allow loans for specific reasons (typically the same reasons
that apply to hardship withdrawals), although some plans place no specific
restrictions on what the need or use will be. You must consult your plan
document for specifics.
Once you borrow against your account, you will be required to make payments
back to your account through payroll deduction. You must repay the loan
within a five year period (although this can be extended for a home purchase).
Although the money for the loan has been withdrawn from your account,
it is still counted as part of your plan assets, as a sort of liability.
However, if you were to terminate employment, your distribution would
be decreased by the amount of an outstanding loan. (See our discussion
on Loan Defaults below.)
Advantages. While plan loans, like other distributions prior to retirement, should
be minimized, there are several advantages in applying for a plan loan
versus a traditional bank loan. A plan loan is convenient. There is no
credit check or long credit application form. Some plans only require
you to make a phone call, while others require a short loan form. (Plans
may also require a spousal consent.) The interest rate is relatively low
and set by the plan, typically one percentage point above the prime rate.
(The current prime rate can be found in the business section of your local
newspaper or the Wall Street Journal.) And the interest you do pay is
paid to your retirement account, not to the bank or Credit Card Company.
Disadvantages. There are also some serious drawbacks to receiving a participant loan,
and these should be given much consideration. Since the interest rate
paid on a plan loan is often less than the rate the plan funds would have
otherwise earned, you miss out the added growth to your account. Often,
because you now have a loan payment, you may reduce the amount you are
contributing to the plan and further reduce your long-term retirement
account balance. Interest paid on the loan is not tax deductible, even
if you borrow to purchase your primary residence, and you have no flexibility
in changing the payment terms of your loan. There are also one-time set
up fees and annual maintenance fees required to administer your loan.
Also, you are "double taxed" on your loan amount; you are taxed
on the amount of your loan when you eventually withdraw the funds (at
retirement or termination of employment) and, since your loan repayments
are made on an after-tax basis, you are taxed as you repay the loan balance.
Finally, you should consider the possibility of defaulting on your loan,
which causes serious financial consequences. If an employee quits or is
terminated, the loan must be repaid in full, normally within sixty days.
Should the plan participant fail to meet the deadline, a default would
be declared and penalties and taxes assessed.
It is generally accepted that you probably shouldn't take a plan loan
if situations where you are planning to leave your job within the next
couple of years; there is a chance you will lose your job due to a company
restructuring; you are nearing retirement; you can obtain the funds from
other sources; you can't continue to make regular contributions to
your plan and pay your loan; you can't pay off the loan right away
if you are laid off or change jobs; you need the loan to meet everyday
living expenses; or if you want the money to purchase some luxury item
or pay for a vacation.
Credit Reporting Loans from your retirement plan, even in the case of a
loan default, are not reported to credit-reporting agencies, and will
not negatively impact your credit rating. But if you are applying for
a mortgage, lenders will ask you if you have such loans and they will
count the loan as debt.
Plans are not required to let former employee take plan loans and few allow
them to do so."
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