What you should Consider Before Borrowing from your Pension Plan

People are taking "Qualified Distributions" or "Hardship Distributions"  from their company 401(k) plans at a rapidly accelerating rate to pay regular bills and house payments.  When people lose their job, get sick or get divorced, money pressures can force them to turn to their pension plans as a source of cash, but the costs are very high and the long term effects can be devastating on retirement income. There is no way to replace the contribution amounts that are borrowed (if the loan is not repaid in a timely manner) and the remaining money in the plan would have to earn much higher rates of return of offset the distribution.

A "Qualified Distribution" is available for people over 59 1/2 or the age specified for distributions by your plan sponsor. A distribution means paying income taxes on the full amount of the distribution at your current tax rate. 

A "Hardship Distribution" applies when people younger than the distribution age specified in the plan need money. There is also a 10% penalty in addition to the current taxes imposed by the IRS on hardship distributions. About 20% of corporate plans allow for hardship distributions, so check with your plan administrator about the availability of this option.

Some Plans are more Flexible

Most people are unaware that about 5% of Company Sponsored 401(k) plans have a provision that allows the planholder (you) to borrow against your plan assets.  There is one company (one of the pioneers of "Money Market" mutual funds) that markets a Debit Card program to very large employers.  Your plan may have this option.

For whatever reason there has not been widespread adoption of this type of loan provision, so you will need to check with your Human Resources Department and you should ask for a copy of your Company Retirement "Plan Document" which outlines all of the provisions of your plan and keep it with your important documents.

If your plan does not offer a loan provision, or if you have an orphan 401(k) plan from a previous employer or IRA accounts there is another option available if you are a self employed sole proprietor or sole practitioner and that option is to do a non-taxable rollover or direct transfer from your orphan accounts into a Self Directed 401(k) plan that has a loan provision.

Well drafted Self Directed Qualified Plans  include the legal provision for plan loans of up to $50,000 or 50% of assets in the plan for personal loans.  These loans are amortized over 5 years and you pay interest based on the prime rate, plus 1% at the time you make the loan (to yourself, from the plan).  The loan must have regular payments not less than once quarterly (every three months) and you must make the payments, or the loan will be treated as a distribution and you will be taxed if you are over 59 1/2 or taxed and penalized if you are younger.  A longer amortization period of 20 years is available for home purchases.  Most well drafted plans also allow distributions to start at age 55 instead of 59 1/2 and this can be a real benefit.

The proceeds from this personal loan may be used for any purpose.  You can pay bills, buy a car or make an investment or loan to a friend or family member.

You should consider this option before taking a hardship distribution from a company plan that does not have a loan provision.  If you are self employed and set up a Self Directed Plan 401(k) or other Qualified Plan and you know with reasonable certainty that you can make the regular payments that are required, you will have the opportunity to replace the money you borrow from your plan and preserve a much better retirement than will be possible for those who pay the high price for Hardship Distributions.