Tax Consequences of Borrowing From a Retirement Plan

If your company has a qualified retirement plan or you have set one up in self employment — such as a 401(k), profit-sharing, or Keogh plan — the participants might be allowed to borrow from their accounts. (This option is not available for traditional IRAs, Roth IRAs, SEPs, or SIMPLE-IRAs.)

In the right circumstances, taking out a plan loan can be a smart financial move because a participant gains access (within limits) to his or her retirement account money without having to pay taxes. Plus, when the loan is repaid with interest (which is generally at a reasonable rate), the participant is effectively paying the interest to him or herself rather than to some commercial lender. But there is a caveat: A participant must be prepared to pay back the borrowed money on time or face potentially dire tax consequences.

Here are some answers to frequently asked tax questions about retirement plan loans that you can pass

along to your employees:

Question: How much can I borrow?

Answer:

The maximum you can borrow from a qualified retirement plan is generally:

● The lower of $50,000 or

● Half of your vested account balance.

Most plan loans are secured exclusively by the borrower’s vested account balance, although that’s not always the case.

Question: What are the drawbacks?

Answer:

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