Taxation & Estate Planning

BORROWING FROM A QUALIFIED PLAN

By Charles Rubin

In times of economic contraction, retirement plan participants often look to their plan as a source of loans to help them through cash flow difficulties. This is especially so for the many taxpayers that have a large part of their savings tied up in retirement plans. If done properly, such loans can be made without adverse tax consequences, so long as they are repaid in a timely manner. Such loans will not be treated as a taxable distribution from the plan.

These loans may provide interest rates better than those available from banks and other lenders. Importantly, the interest paid by the participant goes back into the participant?s plan account, instead of being lost forever to a third party lender as would be the case in for a bank loan.

Loans are permitted for profit sharing and 401(k) plans, but not from SEP or Simple IRAs. The plan must specifically allow for such loans.

There are a number of provisions that restrict deductibility of interest, both within the pension rules and under general Code provisions restricting deductions of personal interest.

The basic requirements for a qualified loan include the following:

a. LOAN AMOUNT. The loan amount can't exceed the lesser of (1) $50,000, or (2) 1/2 of the present value of the employee's nonforfeitable accrued benefit under the plan. But a loan up to $10,000 is allowed, even if it's more than half the employee's accrued benefit.

b. LOAN TERM. Generally, the plan loan must be repaid within five years in substantially level payments, made not less frequently than quarterly, over the term of the loan. Special rules apply as to the repayment term for loans to buy a qualified dwelling unit.

c. REPAYMENT. If the participant does not repay the loan in time, it will be treated as a taxable distribution.

d. DOCUMENTS.  The loan must be documented in writing, as required by applicable regulations and plan documents.

Of course, the foregoing is only a general summary. Plan administrators can provide more detailed guidance on implementing loans as to any particular plan.

Full post as published by Rubin on Tax on February 08, 2009 (boomark / email).