The COVID-19 pandemic has been hard on individuals and families. As a result, some people are borrowing from their companies’ qualified retirement plans. The CARES Act includes some temporary rule changes to this loan type. Given the risks of borrowing from a retirement plan, however, this step should be avoided whenever possible. Borrowing from your retirement plan is a problem for you and for your heirs, who will receive little in the event that you pass away before the loan has been repaid.
CARES Act changes
If your plan allows loans, you can borrow up to $50,000 or 50% of your vested account balance under normal circumstances (whichever is less), and you must repay the loan in five years. Interest rates on this loan are often lower than those offered by banks.
The CARES Act changes allow the suspension of loan payment that would have otherwise been due between March 27, 2020, and December 31, 2020 to be suspended for up to one year. Those due after the suspension period are adjusted to reflect interest that accrued during that time.
It also allows individuals who took a plan loan between March 27, 2020, and Sept. 22, 2020, a greater maximum loan amount: either $100,000 minus any existing plan loan balances 100% of the participant's vested account balance or benefit, whichever is less.
Not a free option
Although many people think that borrowing against a retirement plan is a free loan (after all, you pay the interest to yourself), there are still costs involved. You’ll lose the benefits of tax-deferred growth on the amount you borrow, and unless the interest rate you pay equals or exceeds the growth rate of your assets, your account’s value will end up lower than it would have otherwise been.
The loss of contributions is also something to keep in mind. It can be difficult to afford them while you’re repaying a loan, and some plans prohibit contributions until the loan is repaid. This also causes you to forfeit any matching contributions your employer offers.
Payments can accelerate
The biggest risk, however, has to do with what happens if you lose your job. In this case, payments can accelerate, with many employers requiring severed employees to still repay outstanding balances. In the event that the employee is unable to pay, the balance will be subject to taxes, and maybe even penalties.
Please reach out to your trusted Smolin Professional with any questions or concerns.