Pension plans contain contributions from you and your employer that are intended to be used during your retirement years. Pensions grow on a tax-deferred basis, and you stand to lose the taxable benefits and pay hefty penalties if you make premature withdrawals. However, in some instances you can access some of your pension funds by taking out a loan.
Under the federal tax code, employers may include a loan provision in pensions that fall within the parameters of 401(a) and 403 (a) and (b) plans, some government employee annuities and 401(k) plans. Some of these plans are defined benefit plans, which means contributions vary over time, but your eventual withdrawal benefits are fixed. Others are defined contribution plans, in which case there are no withdrawal guarantees but you and your employer can make contributions up to annually set limits. You cannot borrow from SIMPLE IRAs and other types of plans. Your employer is under no obligation to include a loan provision in your plan, as the Internal Revenue Service permits rather than requires loan provisions.
Maximum Borrowing Limits
You can borrow up to $50,000 in the form of a pension plan loan. However, you cannot borrow more than 50 percent of your vested balance unless that balance is $10,000 or less, in which case you can borrow up to $10,000. Your vested balance is made up of the money you deposited into the account through salary deferrals and your account earnings. It also includes any portion of your employer's contributions that belong to you. Under federal vesting rules, it can take up to seven years before your employer's deposits into the account become vested and belong to you.
The loan term cannot exceed five years. Payments must occur at least quarterly, and the plan administrator must set up repayment terms based on roughly equal payments. A portion of each payment must go toward the principal and interest. Interest rates are usually based on the prime rate. You effectively pay yourself interest, as your entire payment is deposited back into your pension plan. The loan term can exceed five years if you used the money to purchase a home. You can arrange a suspension of the repayments if you are called away on military service. When you return to work, you must make up the payments so the loan term does not exceed the original five-year term.
If you leave your job, you must immediately repay any outstanding retirement plan loans. If you do not repay the loan, the IRS recharacterizes the loan as a fully taxable withdrawal. You may have to pay a 10 percent tax penalty as well as state and federal income tax on the outstanding balance. Additionally, loan repayments are deducted from your salary on an after-tax basis. This means you pay taxes on the same funds twice, as you will pay tax on the money again when you make an eventual withdrawal.
- IRS.gov: Retirement Plans FAQs Regarding Loans
- United States Department of Labor: What You Should Know About Your Retirement Plan
- IRS.Gov: 401(k) Resource Guide -- Plan Sponsors -- General Distribution Rules
- IRS.Gov: SIMPLE IRA Plan FAQs
- IRS.gov: Retirement Plans FAQs Regarding 403(b) Tax-Sheltered Annuity Plans
- IRS. "Retirement Topics - Plan Loans." Accessed Nov. 2, 2020.
- FINRA. "401(k) Loans, Hardship Withdrawals and Other Important Considerations." Accessed Nov. 2, 2020.
- IRS. "Relief for Taxpayers Affected by COVID-19 Who Take Distributions or Loans From Retirement Plans." Accessed Nov. 2, 2020.
- Charles Schwab. "The Charles Schwab Guide to Finances After Fifty: Does It Make Sense to Borrow From My 401(k) if I Need Cash?" Accessed Nov. 2, 2020.
- Maxwell Locke & Ritter. "Options for Your 401(K) Plan at a Former Employer." Accessed Nov. 2, 2020.
- IRS. "Retirement Plans FAQs Regarding Loans." Accessed Nov. 2, 2020.
- The Pension Research Council at the Wharton School. "Financial Literacy: Implications for Retirement Security and the Financial Marketplace: Chapter 4: Financial Literacy and 401(k) Loans," Page 71. Accessed Nov. 2, 2020.
- IRS. "Retirement Topics - Bankruptcy of Employer." Accessed Nov. 2, 2020.