Pension and profit-sharing pension plans often have provisions permitting employees to borrow from their retirement accounts. As long as the employee pays back the loan according to the specified terms, the money is not taxed as a withdrawal from the plan. Pension loan approvals are also much faster than bank loan approvals because they do not require a credit check.
The interest paid on a pension loan is redeposited into your account instead of being paid to a bank. This allows your retirement assets to continue growing during the years of the loan. Depending on the state of the economy, this fixed interest rate may be higher or lower than the rate you would have earned by investing in stocks or mutual funds. Pension loans are not subject to credit approval, so they may be the only option available to employees with past financial troubles.
A pension loan must be paid back within five years unless the money is borrowed to purchase a new primary residence. If you use the loan to purchase a home, the repayment period is extended to 10 years. Payments are due at least quarterly, but may be monthly, biweekly or weekly, depending on the provisions of the pension plan document. The loan balance is amortized over the repayment period to determine the required payment amount and the breakdown of principal vs. interest. If you take a leave of absence from the company, your loan payments may be suspended for up to 12 months. The missed payments must be paid back before the end of the loan term.
The maximum loan amount depends on the language of your employer's pension plan. However, the Internal Revenue Service imposes certain limits on all pension loans. For employees with vested plan account balances between $20,000 and $100,000, the loan may not be more than half of the vested balance. Employees with more than $100,000 in their vested account are limited to loans of $50,000 or less. Employees with small account balances may borrow up to $10,000.
The outstanding balance of your loan is a taxable withdrawal if you leave the company and take your pension funds with you. If you are under 55 years old, this amount will also be subject to an early withdrawal penalty of 10 percent. To avoid taxation and penalties, you must pay off the entire loan or leave your money in the employer's pension plan while you continue to make your scheduled loan payments.