Retirement Topics - Loans
Profit-sharing, money purchase, 401(k), 403(b) and 457(b) plans are allowed to offer loans to participants, but a plan sponsor is not required to include these provisions in its plan. To determine if a plan offers loans, check with the employer, plan sponsor or plan administrator or the Summary Plan Description.
IRAs and IRA-based plans ( SEP, SIMPLE IRA and SARSEP plans) cannot offer participant loans. A loan from an IRA or IRA-based plan would result in a prohibited transaction.
To receive a plan loan, a participant must apply for the loan and the loan must meet certain requirements. When a participant requests a loan, he or she should receive information from the plan administrator describing the availability of and terms for obtaining a loan.
Maximum Loan Amount - The maximum amount a participant may borrow from his or her plan is 50% of his or her vested account balance or $50,000, whichever is less. An exception to this limit is if 50% of the vested account balance is less than $10,000: in such case, the participant may borrow up to $10,000. Plans are not required to include this exception.
Examples:
Bill’s vested account balance is $80,000. Bill may take a loan up to $40,000, which is the lesser of 50% of his vested account balance and $50,000.
Sue has a vested account balance of $120,000. Sue may take a loan up to $50,000, which is the lesser of 50% of her vested account balance of $120,000 ($60,000) or $50,000.
Repayment Periods - Generally, the employee must repay a plan loan within five years and must make payments at least quarterly. The law provides an exception to the 5-year requirement if the employee uses the loan to purchase a primary residence.
Loans to an employee that leaves the company. Plan sponsors may require an employee to repay completely a loan if he or she terminates employment. If the employee is unable to repay the loan, then the employer will treat it as a distribution and will report it to the IRS on Form 1099-R. The employee can avoid the immediate income tax consequences if he or she is able to come up with the loan’s outstanding balance, within 60 days and rolls over this amount to an IRA or eligible retirement plan.
Loans that do not meet legal requirements are considered "deemed distributions.” For instance, if the loan repayments are not made at least quarterly, the remaining balance is treated as a distribution that is subject to income tax. If the employee continues to participate in the plan after the deemed distribution occurs, he or she is still required to make loan repayments. These amounts are treated as basis and will not be taxable when later distributed by the plan.
Loans to an employee in the armed forces. If the employee is in the armed forces, the employer may suspend the loan repayments during the employee’s period of active duty and then extend the loan repayment period by this period.
If during a leave of absence from his or her employer, an employee’s salary is reduced to the point at which the salary is insufficient to repay the loan, the employer may suspend repayment up to a year. Unlike the exception for active members of the armed forces, the loan repayment period is not extended and the employee may be required to increase the scheduled payment amounts in order to pay off the loan in the originally scheduled period.
Spouse’s Consent. Some qualified plans require a participant’s spouse’s written consent before giving a loan greater than $5,000. Other qualified plans may not require the participant’s spouse to sign for a loan, regardless of amount, if the plan:
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is a profit-sharing plan (e.g., a 401(k) plan);
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requires that the plan’s death benefit be paid in full to the surviving spouse (unless the spouse has consented to another beneficiary);
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does not offer a life annuity option in the plan; and
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does not contain a direct transfer from another plan that was required to provide a survivor annuity.
Should You Borrow from Your Retirement Plan?
Before you decide to take a loan from your retirement account, you should consult with a financial planner, who will help you decide if this is the best option or if you would be better off obtaining a loan from a financial institution or other sources.
Additional Resources:
Retirement Plan FAQs Regarding Loans
Retirement Plans FAQs regarding IRAs
Retirement Plans FAQs regarding USERRA and SSCRA
The Fix Is In: Common Plan Mistakes - Participant Loans in 401(k) Plans
The Fix Is In: Common Plan Mistakes - Plan Loan Failures and Deemed Distributions
EP Examination Process Guide - Section 9 - Participant Rights - Participant Events - If a Participant Requests a Loan
