The Facts About Retirement Savings Plan Loans

The Basics on Retirement Savings Plan Loans

What exactly is a retirement savings plan loan? Very simply, it's a program that allows you to borrow from your retirement savings account to meet critical, immediate cash needs. Your retirement plan investments are sold and lent to you. Then, over time, you pay the loan back with interest. However, unlike a traditional loan, such as a mortgage, the interest you pay is deposited back to your retirement savings plan.

Here is the basic information you should know about a retirement plan loan.

1. Loan Amount - Assuming that you haven't taken any other plan loans in the last 12 months, federal regulations allow you to borrow up to 50% of your vested account balance, up to a maximum of $50,000. You must have at least a $2,000 vested account balance before applying for a Line of Credit
2. Interest Rate - The interest rate from the retirement plan is the prime rate. The current prime rate can be found on the web or the Wall Street Journal.
3. Loan Fees - There are fees to establish a Line of Credit, and monthly fees as a percentage of borrowed amounts to administer the loan program investment trading, cash processing, provide the loan card, and process your payments. Please refer to the Loan Fees and Other Disclosures for more information.
4. Income Tax and Penalties - The loan is not subject to any immediate income taxes or the 10% early withdrawal penalty unless you fail to repay the loan in accordance with the terms of your plan and applicable law. In order to avoid a taxable distribution from the plan, you must make the monthly payments. If payments are behind and you default on the loan, the law requires the unpaid loan and interest to be treated as income for tax purposes the calendar quarter after payments stopped. If you are under 59½, the amount is also subject to a 10% additional tax for early withdrawal. If you default on a loan, you may not borrow from the retirement plan again.
5. Payment Process - The loan must be repaid monthly and cannot exceed 60 months (5 years). You will receive a monthly statement and invoice. You can make your payments with Automated Clearing House (ACH) transfers from your bank account, which will be processed monthly, or you may make your payments by writing a check to The Contractors Plan.
6. Payment in Full - You can always repay your loan in full at any time with no penalties.
7. Consents - If you are married and your account is over $5,000, the law requires the consent of your spouse before you can obtain a loan.

Things You May Wish to Consider When Deciding Whether to Take a Loan

1. While there is no credit check, is taking a loan your best course of action?
2. The interest rate is typically lower than the rate charged for unsecured loans but do you really need to borrow from your plan?
3. The interest rate you pay yourself on your plan loan might be less than the returns on your plan investments.
4. There are administrative fees that you must pay to process the loan program. You should consider the cost for the loan. While it costs less to borrow from the retirement plan than most other credit sources, consider these carefully before you borrow from the plan.
5. After taking a loan, you may be tempted to reduce or stop your contributions to the plan if you are in a 401(k) and thus reduce your final retirement account. Make every effort to avoid this. It is not in your best interest.
6. Loan defaults can be harmful to your financial health. If you can't repay the loan, it is considered defaulted. Should this occur, the outstanding loan balance will be taxed as current income and you'll incur an early withdrawal penalty of 10% if you are not at least age 59½. You also lose your right to borrow from the plan in the future.
7. Interest on the loan is not tax deductible, even if you borrow to purchase a primary residence.