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If and When to Borrow from a Qualified Retirement Plan

Loans from qualified plans will be considered taxable distributions from the plans unless certain requirements are satisfied. The maximum plan loan an employee may take is $50,000, but the loan amount may be further limited based on the amount of previous plan loans taken by the employee. In general, a qualified plan loan is better from an overall perspective than an outside loan if the growth rate of the plan assets is lower than the interest rate on the plan loan and lower than the interest rate on an equivalent outside loan. An outside loan is better if the growth rate of the plan assets is greater than the interest rate on the outside loan and greater than the interest rate on an equivalent plan loan. However, if the growth rate on the plan assets is greater than the interest rate on a plan loan but less than the interest rate on an outside loan, a plan loan will generally be better, but possibly not significantly better. Whether the interest on the prospective loan will be deductible does not significantly affect the determination of whether a plan loan or an outside loan is more desirable. However, if the interest on an outside loan is deductible, but the interest on a plan loan is not (e.g., because the loan is to a key employee), the plan loan becomes less desirable. A downside to plan loans is that they may terminate on the occurrence of certain events (such as a severance from employment) that will not affect an outside loan. In addition, taking an unneeded plan loan to boost the growth rate of an employee’s qualified plan account could possibly result in a prohibited transaction subject to substantial penalties.