Loans from 401(k) Plans

401(k) Loans View This Newsletter: Keeping Abreast of Plan Loan Rules


If you have a 401(k) plan, you’ve likely had participants ask about taking loans from their accounts. If you haven’t yet, it is only a matter of time. While the concept of taking a loan is pretty straightforward—you borrow money, you repay it with interest—there are some pretty detailed rules that govern loans in the retirement plan world.

  • Background
    • One of the advantages that qualified retirement plans provide is that there are strict rules designed to protect plan assets from misuse, either accidental or intentional, by plan fiduciaries or other interested parties.
  • Loan Requirements
    • Most of the loan rules are written as “bookends” of sorts in that they describe the outside limitations and allow flexibility within those parameters.
  • Plan Document
    • Must specifically authorize participant loans
    • This election must be communicated to all participants
  • Loan Policy
    • Must be in writing
    • Can be baked into the plan document itself or can be a separate written policy
  • Maximum and Minimum Amounts
    • Participants can only take loans totaling up to 50% of their vested balances.
      • The maximum combined loan balance cannot exceed $50,000.
    • The most common minimum loan amount is $1,000
  • Number of Loans
    • The law does not impose a maximum
    • Many plans limit participants to only one or two loans at a time to minimize the administrative burden or to keep participants from using the plan as a revolving account.
  • Interest Rate
    • Must be similar to what a commercially reasonable rate would be for a loan of similar terms
    • Participant loans are not variable rate loans.
  • Amortization
    • The maximum length of time a participant loan can be outstanding is five years.
    • Exception if loan is to purchase a primary residence
  • Other Repayment Terms
    • Method: plans typically require participants to repay their loans through payroll deduction
    • Employment Termination: Each plan can determine the repayment terms in this situation
    • Frequency: Level payments of principal and interest must be made at least quarterly
    • Taxation: Loan repayments are made on an after-tax basis
  • Documentation
    • Participant loans must be documented
    • Must be enforceable under state law
  • Conclusion
    • The 401(k) plan loan rules are designed to protect plan assets from misuse and preserve tax-favored retirement benefits.
    • Having a clearly documented loan policy and communicating it to participants is a best practice.
Pinnacle Plan Design is a third-party administrator (TPA) for employer-sponsored qualified retirement plans. We specialize in retirement plan design, administration and actuarial consulting for 401(k)/profit-sharing plans, defined benefit plans, cash balance plans, and 403(b) plans. Pinnacle Plan Design proudly serves businesses nationwide.
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