Loans from a company 401(k) plans should be strongly discouraged. Your retirement plan is not intended to be your emergency fund. The future of you and your family will be adversely affected.
CM:How do loans affect participants?OM: A plan loan is capped at half the account balance or $50,000, whichever is less, and the employee must immediately begin repaying the loan to him/herself. Failure to pay back, for instance, at job termination, results in the unpaid loan amount being subject to income tax (as well as a penalty tax if the individual is younger than age 59-1/2).
According to Employee Benefit Research Institute (EBRI) research, 21% of partcipants have plan loans with an average loan balance of 15% of total assets, or $7,346.** A Vanguard report from earlier this year indicates participants with no loans have balanaces that are, on average, 12% larger that those with loans. ***
What is worrisome is the loss of a significant portion of a participant’s balance as repayment for a loan at retirement. With balances already considerably less than those without loans, most can’t afford any “leakage”.
CM: What about plan distributions when leaving an employer… do most roll it over to an IRA or new plan, or do they just cash out?
OM: Someone who takes a plan distribution in the form of cash prior to the age 59-1/2 will have to include the payment in reported income for the purposes of income tax, plus pay to the IRS an additional penalty of 10% of the lump sum (only the income tax applies after age 59-1/2). If the plan distribution takes the form of a rollover to an IRA, or to a new employer pension, the income and penalty tax is not charged.
The Vanguard study cited earlier shows 30% of those leaving an employer cash out their 401(k) balance.
Steps can be taken to control the ‘leakage’ or loan program in your plan.
Please comment or call to discuss how this affects you and your organization.
- Senate Bill Would Limit 401(k) Loans (money.usnews.com)
- 401(k) Plans (turbotax.intuit.com)
- Tax Tips for Retirement (turbotax.intuit.com)