Retirement Plan Participant Loan FAQs
The regulations governing loans to participants from a retirement plan are very strict and if not followed may result in penalties or plan qualification issues. The following is a summary of the loan requirements:
- Loans must be available to all participants on a nondiscriminatory basis.
- Loans may not exceed the lesser of $50,000 or 50% of a participant's vested benefit.
- This maximum amount may be reduced by the highest outstanding loan for that participant in the preceding 12 months as well as the current balance of any existing outstanding loan.
- These maximums apply in total for all retirement plans of your company or any of its affiliates.
- A plan's own loan policy will dictate other restrictions that may apply such as minimum loan amount, maximum number of loans for a participant at any time, purposes for which a loan will be granted, etc.
- A written note agreement is required to be signed by the participant and approved by the Trustee. Spousal consent may be required for loan approval.
- The maximum term for a loan is 5 years. Loans used for purchase of a primary residence may exceed 5 years: no more than 10-15 years is recommended. Please refer to your Plan's loan policy to determine the maximum term for purchase of a participant's primary residence.
- Loan payments shall be made via payroll deduction. If payroll deduction is not an option, the loan payment must be made via an ACH debit from the participant's checking account. NOTE: Repayment must be done on an after-tax basis. Salary deferrals in a 401(k) plan may not be used to repay the loan.
- The interest rate charged for the loan must be "reasonable." This means that it must be commensurate with the interest rate charged by commercial lenders for loans under similar circumstances. Interest paid on a loan for the participant's principal residence may be eligible for income tax deduction. This deduction is not allowable if the participant is a key employee or if the loan was secured from the participant's elective deferrals under a 401(k) plan.
- Loans may be prepaid or paid off in one lump sum at any time during the repayment period without penalty.
- A loan is considered as being in default if payment is not made by the last day of the quarter following the quarter in which the payment was due. A defaulted loan is a taxable event, reportable on Form 1099-R.
- If an unpaid loan balance is "distributed" as part of a participant's termination benefit, the calculation of income tax withholding for that distribution must take into account the unpaid loan balance.
- Under certain conditions a loan may be "refinanced" to lower the interest rate or obtain additional funds. However, the refinanced loan's repayment period may not exceed that of the original loan. Please refer to your Plan's loan policy to determine if refinancing is allowed.
- Special loan repayment rules apply to members of the military who are on active duty that may allow those individuals' loans to be suspended for a period of time.