Can I Borrow Money Against My Pension?

Can I Borrow Money Against My Pension?
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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.

Basics of Pension Plans

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 403(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

As of 2021, the IRS says that 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. You can consult your pension plan's documentation or ask the plan administrator for specifics on the vesting requirements.

Term of a Pension Loan

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.

Considerations for Pension Loans

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.