How Company Plan Loans Work
Most company retirement savings plans, such as 401(k), 403(b) and 457(b) plans, are allowed to (but not required to) offer plan loans. According to a survey by the Employee Benefits Research Institute, as of the end of 2022, 52% of 401(k) plans allowed loans, while 84% of 401(k) participants were in plans offering them. Loans are not allowed from IRAs, SEP IRA plans or SIMPLE IRA plans.
Plan loans are generally limited to the lesser of 50% of your vested account balance, or $50,000. Your employer can allow an exception to this rule: If 50% of your vested account balance is less than $10,000, you can still borrow up to $10,000.
Example 1: 401(k) Plan Loans
Bonnie participates in a 401(k) plan that allows loans. Her vested account balance is $16,000. If the plan doesn’t allow the exception, the most Bonnie can borrow is $8,000. If the plan allows the exception, she can borrow up to $10,000.
Many plans limit participants to one outstanding loan at a time. But some plans do allow participants to take out a second loan while one remains outstanding. The amount of a second loan is limited by the outstanding balance of the first loan.
Generally, you must repay a plan loan within 5 years. But a loan used to purchase your principal residence can have a longer repayment period, usually 10 or 15 years. Loans must be repaid in substantially equal amounts made at least quarterly. Most plans require repayment through payroll deduction.
Advantages of Plan Loans
- If offered by the plan, they are usually available at any time and for any reason.
- As long as the loan satisfies the above rules, it isn’t a taxable distribution or subject to penalty.
- They don’t require a credit check, and the application process is simple and quick.
- They usually offer better interest rates than a commercial loan. Also, repayments are made back to your account – not to a bank.
Disadvantages of Plan Loans
- Amounts borrowed are unavailable for investment growth within the plan.
- If you leave your employer with an outstanding loan balance that you can’t pay off, your plan account will be offset by the loan balance. That balance is considered a distribution subject to tax and possible penalty. You can avoid the tax hit if you can come up with the funds to roll over the unpaid balance to an IRA. The rollover deadline is October 15 of the year following the year the offset occurs.
Example 2: Loan Balances
Clyde, age 50, terminates employment on July 15, 2025, with a $50,000 401(k) account balance and a $20,000 outstanding loan balance. Clyde does not have the funds to repay the loan balance. On August 15, 2025, the plan offsets his $50,000 account balance by the $20,000 loan balance and distributes $30,000 to him. He rolls over the $30,000 to an IRA within 60 days. Clyde has until October 15, 2026, to find other sources to replace the $20,000 so he can complete a full rollover. Otherwise, he will owe taxes on the $20,000 and a 10% early withdrawal penalty of $2,000 for 2025.
By Ian Berger, JD
IRA Analyst
Ed Slott and Company, LLC
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Christian Cordoba, founder of California Retirement Advisors, has been a member of Ed Slott's Master Elite IRA Advisor Group since 2007.