• Skip to primary navigation
  • Skip to main content
  • Skip to primary sidebar
  • Skip to footer
  • Facebook
  • Instagram
  • LinkedIn
  • Twitter
  • YouTube
Big Ideas for Small Business logo

Barbara Weltman

Big Ideas for Small Business, Inc.

Whitepaper download

Subscribe and download our eBook, "150+ Tax Deductions for Small Business A to Z."

This field is hidden when viewing the form
Get the:

  • Home
  • About Us
  • Big Ideas For Your Business
    • Idea Of The Day ®
    • SMB Legal
    • SMB Taxes
    • SMB Financial
    • Small Business
    • Newsletter Archive
  • Services
  • Books
  • Blog
  • Multimedia
    • Videos
    • Radio Shows/Podcasts
  • Be a Guest Blogger

Handling Plan Loans

September 26, 2017 / By Barbara Weltman

Shakespeare said in Hamlet “neither a borrower nor a lender be,” but he didn’t know about 401(k) plans and their ability to offer easy terms for borrowing. If you have a 401(k) plan that permits plan loans, it can be a big help for owners and employees. Understand how much participants can borrow and what plans need to do to stay compliant with the law and remain qualified. Also, understand the negative impact that borrowing can have on retirement savings.
Handling Plan Loans

Parameters of plan loans

A plan is not required to offer participants the option of taking loans. If it does (as an estimated 90% do), the option must be available to all participants on a nondiscriminatory basis (i.e., it can’t be restricted to owners and managers). But being an owner is no bar to the ability to take a loan.

Loans can be made for any reason. The participant does not have to provide a reason or have a serious financial need (as in the case of a hardship distribution).

A plan can set limits on the amount of borrowing. The maximum loan amount permitted by tax law is the lesser of:

  • The greater of $10,000 or 50% of the vested account balance
  • $50,000

For instance, if an account balance is $40,000, the maximum loan is $20,000 (50% of the account balance). If the account balance is $120,000, the maximum loan is $50,000 (which is less than 50% of the account balance). Additional limits come into play if there are already loans outstanding.

The loan must be repaid within 5 years (longer for borrowing to buy a home). Payments (including interest) must be made ratably over the term of the plan; payments must be made at least quarterly (with repayment suspended for a leave of absence of up to one year or for military service).

The plan must charge a commercially reasonable rate of interest. The IRS treats the prime rate plus 2% as a reasonable rate of interest, although this is not an official safe harbor for a commercially reasonable rate of interest. The interest is being repaid to the participant’s account, but likely is not tax deductible. The plan can charge a loan origination fee.

You can find more details about plan loans from the IRS.

Plan loans for hurricane victims

The IRS reminds us that plans can make loans to victims of Hurricanes Harvey and Irma. What’s better is that the IRS is relaxing the procedural and administrative rules that normally apply to plan loans. For example, even if a plan doesn’t currently allow loans, it can make them and then amend the plan to permit loans.

Distinguish between plan loans and hardship distributions.  Hardship distributions are taxable to the participants (and subject to a 10% penalty if the participant is under age 59½). Once the funds are distributed, they can’t be repaid to the plan. However, the IRS is allowing plans to make hardship distributions to victims of Hurricanes Harvey and Irma without causing a loss of qualified status.

Caution about borrowing

Using a 401(k) as a piggy bank is inadvisable. It depletes retirement savings, even though borrowed amounts are repaid to the plan. The reason: Borrowers usually reduce their annual contributions to the plan while they’re repaying the loan.

What’s more, if funds aren’t paid on time or an employer leaves the company without repaying the funds, there’s a distribution that’s taxable (and subject to a 10% early distribution penalty if the borrower is under age 59½). The IRS informally explains how missed payments can be cured to avoid a deemed distribution.

Bottom line

Having the option to borrow from a 401(k) plan may be a good thing. For owners, it may be a quick solution to meet payroll in a cash crunch. For employees, knowing that their contributions are accessible through a loan may induce them to make contributions. However, the National Bureau of Economic Research reported that at any point in time about 21% of active participants had an outstanding plan loan, and over any point in a 5-year period it was 37%. Overall this can’t be a good thing for retirement savings. 

Tags 401(k) borrowing plan loans retirement savings

Primary Sidebar

Categories

  • General Business (498)
  • Guest Blog (109)
  • Homepage (21)
  • Small Business (990)
  • SMB Financial (322)
  • SMB Legal (66)
  • SMB Taxes (324)

Barbara’s Recent Posts

  • Scale Your Business by Stepping Up IP Protection May 29, 2025
  • Disasters Happen: It’s Important to Be Prepared Now May 27, 2025
  • How Work Order Software Transforms Small Business Operations May 26, 2025
  • The Numbers Are Up for Sole Proprietorships May 22, 2025
  • New Business or Project Crowdfunding: What To Know May 20, 2025
  • Old-School Estimating vs. Smart Solutions: What’s Really Holding You Back? May 19, 2025
  • Employees Getting Called to Public Service: What to Know May 15, 2025
  • Not Too Late to Prep for Summer Now May 13, 2025
  • How Will the Next Generation of Learners Affect the Workplace May 12, 2025
  • Moms Know Best: Lessons for Entrepreneurs May 8, 2025
  • Mental Health Challenges in the Workplace May 6, 2025
  • Let’s Celebrate Small Business! May 1, 2025
Awarded Top 100 Small Business Blog medal (link will open in a new window or tab)
Marquis Who's Who 2023 Badge
Top Small Business Blogs (Link will open in a new window or tab.)
8 Financial blogs small business Owners Need to Read. Invoice home.  (link will open in a new window or tab)
Best Small Business Blog, Expertido.org
Top 50 Small Business Blogs 2018
Best Small Business Blogs
BizHumm Top 100 Business Blog Award to Barbara Weltman
FitsSmallBusiness.com: Award for Best Small Business Blog 2017 (link will open in a new window or tab)
FitsSmallBusiness.com: Award for Best Small Business Blog 2016 (link will open in a new window or tab)

Footer

Big Ideas for Small Business logo

Small business ideas, business tax news and small business consulting from Barbara Weltman to provide business owners with the information they need to succeed. Visit our small business blog, Idea of The Day®, small business books and articles on small business taxes, small business finance and small business legal advice.

Contact Us

[email protected]

(772) 492-9593

gacor maxwin situs slot thailand terpercaya situs slot gacor situs gacor akun pro thailand slot bandar togel terpercaya

Latest Tweets

bigideas4sb Big Ideas for Small Business® @bigideas4sb ·
May 30

Can AI Enable Us To Focus More on the Work We Love to Do? https://bit.ly/4jes1jI #smallbusiness #AI #focus #software #productivity

Reply on Twitter 1928543784310079906 Retweet on Twitter 1928543784310079906 Like on Twitter 1928543784310079906 1 Twitter 1928543784310079906
bigideas4sb Big Ideas for Small Business® @bigideas4sb ·
May 30

??

Reply on Twitter 1928489888023724097 Retweet on Twitter 1928489888023724097 Like on Twitter 1928489888023724097 Twitter 1928489888023724097
bigideas4sb Big Ideas for Small Business® @bigideas4sb ·
May 30

Social Media Impressions Explained: What They Are and Why They Matter https://bit.ly/3G7X4ze #socialmedia #smallbusiness

Reply on Twitter 1928466810376007985 Retweet on Twitter 1928466810376007985 Like on Twitter 1928466810376007985 Twitter 1928466810376007985
Load More

Copyright © 2008–2025 Big Ideas for Small Business, Inc  |  Designed by Hudson Fusion

  • Privacy Policy
  • Sitemap