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Thin(k) About Your 401(k) Plan: Dig A Little Deeper – 401(k) Plan Loans

 

Many 401(k) plans offer participant’s the ability to take a loan against their vested account balance.  But, do participants fully understand the implications of borrowing from themselves through their retirement account?  Like most financial decisions, there are pros and cons to taking a loan from your 401(k) account that depend upon your individual situation.

Here are a few:

  1. When a participant borrows from her 401(k) plan account, she must pay back the loan amortized over a certain period of time, generally limited to 5 years (with certain exceptions, such as purchasing a primary residence).
  2. Because the participant has borrowed from herself, she pays herself interest generally at a rate of Prime plus 1%-2%. This generates growth on the uninvested / borrowed dollars, but tax implications have an impact too because the participant is repaying the loan with after tax dollars.
  3. The amount of the loan available is limited to the lesser of 50% of her vested account balance or $50,000.
  4. Here is a tricky one. If the participant terminates employment prior to repaying the loan in full, some plan sponsors may require repayment in full at the time of termination.  If the participant is unable to repay the loan, the outstanding balance may be treated as a distribution subject to income tax consequences potentially including a 10% early distribution tax (penalty).  Because this is a complex condition, prior to borrowing from your plan, you should make sure you fully understand how termination will affect your loan as dictated by your plan’s rules.

Participants generally view having access to borrow from their 401(k) accounts as a positive benefit.  However, you owe it to yourself to fully understand the terms and ramifications of the loan prior to borrowing the money.  For guidance from the IRS on Plan Loans, please follow the link below.

https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-loans

 

For disclosures, please click here.

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