Can I Borrow From My Pension or Retirement Plan?

Borrowing from a retirement plan can offer a source of funds. While “pension” is often used broadly, borrowing typically applies to specific defined contribution plans. These are individual accounts where contributions are made by the employee and often the employer. Such loans allow access to funds without immediate taxes or penalties if structured and repaid according to regulations.

Eligibility and Plan Types

Loan availability varies significantly by plan type. Defined contribution plans, such as 401(k)s, 403(b)s, and governmental 457(b) plans, commonly permit loans from vested account balances. However, not all plans offer this feature, as plan sponsors can choose to include or exclude it. Conversely, traditional defined benefit pension plans generally do not allow borrowing against future benefits. Similarly, individual retirement accounts (IRAs), including Traditional and Roth IRAs, typically prohibit loans.

To be eligible for a loan, individuals must be active employees with a vested plan balance. Vested funds are the portion of the retirement account an employee fully owns, including their contributions and any employer contributions that have met the vesting schedule. Participants should consult their plan’s Summary Plan Description (SPD). This document, often available through HR or the plan administrator, outlines loan permissions and eligibility criteria.

Loan Structure and Repayment Terms

Retirement plan loans operate under specific federal regulations. The maximum amount a participant can borrow is generally the lesser of $50,000 or 50% of their vested account balance. An exception allows borrowing up to $10,000 if 50% of the vested balance is less than this amount, though plans are not required to offer it. For example, if a vested balance is $80,000, the maximum loan is $40,000; if it is $15,000, the maximum could be $10,000 if the plan allows the exception.

Interest rates for these loans are set at the prime rate plus one or two percent, though this varies by plan. A distinctive feature is that interest paid on the loan is repaid directly back into the borrower’s own account. This differs from conventional loans where interest goes to an external lender.

The repayment period for a retirement plan loan is limited to five years. However, if used for a primary residence purchase, the term can extend significantly, often up to 15 or 30 years depending on the plan. Repayments are usually made through regular payroll deductions. These deductions are made with after-tax dollars.

These loans do not require a credit check, as they are secured by the participant’s vested retirement account balance. The loan does not appear on a credit report and will not directly impact an individual’s credit score. When applying, individuals should gather information such as the desired loan amount and their preferred repayment schedule. Their plan administrator or online portal will provide specific application forms and procedures.

Understanding Tax Treatment and Account Impact

Failure to repay a retirement plan loan can lead to significant financial and tax consequences. If not repaid on time, the outstanding balance is treated as a “deemed distribution” by the IRS. This means the unpaid loan balance is considered taxable income for the year in which the default occurs.

In addition to being taxed as ordinary income, a deemed distribution is also subject to a 10% early withdrawal penalty if the participant is under age 59½, unless an exception applies. While a deemed distribution is a taxable event, it does not absolve the participant of the obligation to repay the loan to the plan. Future repayments made after a deemed distribution are treated as after-tax contributions.

Taking a loan from a retirement account impacts investment growth. While interest paid on the loan goes back into the participant’s account, borrowed funds are removed from the investment market during the loan period. This means the money is not actively invested and cannot benefit from market gains. The opportunity cost of lost investment earnings can be substantial over time, even if interest is repaid to the account.

If a participant leaves employment with an outstanding retirement plan loan, specific rules apply. Many plans require the outstanding balance to be repaid in full by the federal tax return due date for the separation year, including extensions. If not repaid by this deadline, the outstanding balance is treated as a deemed distribution, triggering income taxes and the 10% early withdrawal penalty, if applicable. However, some regulations allow rolling over the outstanding loan amount to another eligible retirement plan or IRA by the tax filing deadline, including extensions, to avoid immediate taxation.