The Pros And Cons Associated With Retirement Plan Loans
If extra money is needed, obtaining a loan against the money that has been placed in a retirement plan may be an attractive suggestion. When a significant amount of money has been invested in a retirement plan and the person is not planning to retire in the near future, a retirement plan loan is an easy method to obtain the amount of money desired. There are several things that must be kept in mind when deciding whether this option is right for your situation.
Retirement Plan Loan Pros
The biggest pro associated with retirement plan loans is the ease of acquiring the loan. When the loan is based on the balance of a retirement account, lenders rarely deny the loan because the retirement plan funds are used to pay off the loan in cases of default, guaranteeing that the lender will get their money.
Another pro of retirement plan loans is the swiftness of loan application approval. Traditional loans based on income and debt levels involves the need to verify income or provide documents detailing your net worth, while applying for a retirement plan loan rarely involves these steps. If the total borrowed with the loan is less than the balance of the retirement plan account, the lender should need very little additional documentation for loan approval.
Retirement Plan Loan Cons
Most retirement plan loans have a strict limit on the amount that can be borrowed against the retirement plan. Most lenders state that the loan amount cannot be more than 50% of the vested balance of the account. For example, if the vested balance of the retirement plan account is $50,000, then the maximum loan amount will be $25,000.
Another problem with retirement plan loans is the reduction of capital in the retirement plan account if the person defaults on the loan. Traditional loan options, such as renegotiating the interest rate or refinancing the loan, are not available with retirement plan loans because these loans become payable almost immediately after default and the amount owed to the lender is subtracted from the balance of the retirement plan account.
This balance reduction can be tremendously hard to replace due to annual deposit limitations on retirement plan accounts. If the loan goes into default, the amount of money withdrawn from the plan to pay off the loan is treated as taxable income and the taxes must be paid in the same calendar year.
It is important to understand the positives and negatives associated with retirement plan loans before making a final decision. In some cases, taking out a retirement plan loan is the best option while in others, it may be better to look for other sources of funding.
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