10 Caution Tips On Retirement Plan Loans

During your financial struggles have you ever wished you just had one more source of money?  Believe it or not, you do.  Your retirement plans may just be the source you are looking for….but proceed with caution.   Tapping into your retirement plans is not recommended as your first choice when you need to make ends meet, but rather, your last resort.

Borrowing from your retirement plan may not be your best financial move

Be careful, borrowing from your retirement plan may not be your best financial move.   However if you need the money, a loan is better than a withdrawal.   If handled incorrectly withdrawals can be expensive.   Retirement plan withdrawals before age 59 1/2 will cost you in taxes and penalties; you avoid that expense with a loan.

Keep in mind that you can only borrow from a pension, 401k or 403b retirement plan.   You cannot borrow from a Roth or traditional individual retirement plan, SEP or Simple IRA.

Tip #1 – Are Loans Available?

Since retirement plan loans are not a required option in a 401k retirement plan, not all employers offer them; check with your human resource department.

Tip #2 – Nothing Dramatic

You will not have to endure a credit check or complete a lengthy credit application when you take out a retirement plan loan.  So if your credit scores are not the best and you need money a 401k retirement plan loan may be your best bet.

Tip #3 – Can You Say Cheap?

A retirement plan loan is not officially a loan.   You are simply borrowing your own money from your own retirement plan and paying yourself back.  So the interest rates and administration fees on a 401k retirement plan loan are generally very reasonable.

Tip #4 – How Much Did You Need?

Retirement tax law states that your loan amount is limited to 50% of your vested account balance or $50,000; which ever amount is less.

Tip #5 – Keep It Simple

You will not pay taxes or early distribution penalties on a retirement plan loan.   That changes if you default on the loan.

Retirement loansTip #6 – It’s Pay Back Time

Most employers allow a 5-year payback period for retirement plan loans.   Your employer will set up an automatic payroll deduction to collect on your loan.

Tip #7 – Default Is Bad

If you default on a retirement plan loan you will have to pay taxes and sometimes tax penalties plus you will damage your credit scores.   Loan defaults are reported to the IRS and you will be sent a 1099 form detailing how much you will have to report as taxable income for that year.

Tip #8 – You Left Your Employer?

If you leave your employer while your loans is still outstanding you may lose the 5-year payback cushion.   Most employers speed up the payback period when you quit and may require you to pay your loan back within 60 days.

If you are under age 59 1/2 and are unable to pay your loan back within those 60 days, the government considers that an early distribution.  You will have to pay taxes and penalties on the unpaid portion of the loan.

Tip #9 – Old Money

If you left money in your previous employers 401k retirement plan you will rarely be allowed to take a loan out on that account balance.   You may be better off rolling the money from your old plan into your new company’s plan and then apply for a loan.

Tip #10 – No New Growth

Some employers will not allow new contributions to your retirement plan account while a loan is outstanding.   No new money means no matching and no new growth.   The inability to contribute and receive matches will put you financially behind…think about that before you apply for a loan.

Is It Right?

You may have a large sum of money sitting in your retirement plans and it’s tempting to tap into it when you are struggling.   Tapping into it may seem like the right thing to do.   Maybe it is, maybe it isn’t.   You need to weigh your advantages and disadvantages before signing the dotted line on your loan paperwork.