Defined pension plans used to be offered to 60% of employees in the private sector.
The new number? Today, a mere 4% of employees in the private sector are offered a defined pension plan. However, if you work in government, you may be more likely to have a pension. In 84% of state and local governments, traditional pension plans are still offered.
If you have a pension and are strapped for cash, you may be considering a pension loan. But how do pension loans work? Is it really the best decision?
Keep reading to learn all about pension loans, how they work, and whether it’s the right decision for you.
Defined pension plans (or traditional pensions) are given to an employee so they receive a set amount of income during retirement. Pensions tend to grow tax-deferred, and premature withdrawals are usually penalized two-fold.
First, you lose the tax-deferral when you withdraw early. Secondly, you may even pay hefty penalties and fines if you choose to withdraw early.
However, some pension plans allow you to access the funds prematurely by taking out a loan.
What are Pension Loans?
Pension loans are an advance on your retirement pension. If you are strapped for cash, you may need to tap into your pension early. As mentioned earlier, there are usually penalties for withdrawing your pension early as a loan. Pensions loans are intended for people who find it impossible to raise money elsewhere.
Additionally, pension loans are not always an option granted by your employer. In fact, the Internal Revenue Service (IRS) does not require all employers to grant pension loans, but only offers it as an option.
These options include a loan provision in pensions that fall within a few different plans. These include:
- 401(a) plans
- 403 (a) and (b) plans
- Select government employee annuities and 401(k) plans
- Federal Thrift Savings Plans
Which one is right? It depends on your circumstances.
How Much Can I Borrow?
The Internal Revenue Service sets limits on how much can be borrowed on a pension loan.
As of 2019, the IRS pension loan limits are as follows:
- Either $10,000 or 50% of your vested account balance, or
Your limit will depend on whichever of those two categories is lowest. For example, if your account balance is $50,000, you may take out a maximum loan of $25,000.
Some plans will allow you to take out an additional pension loan, even if you have not paid back the first loan in full. However, provisions must be included in the original plan to do so.
When Do I Have to Pay it Back?
The length of a pension loan is usually limited to five years. Payment plans occur quarterly or sooner, and in equal payments. These payments must cover both principal and interest rates (of which are usually based on prime rates). These funds go right into your pension plan.
Some repayment exceptions are made in special circumstances. These include:
- If the loan was used to purchase a home, your loan term may be longer than five years
- If you are called away to serve in the military
- If you take a leave of absence from work
In the last case, you can expect to make larger payments upon returning to work. This is so the loan is still paid off within five years.
Given the devastation caused by Hurricanes Harvey, Irma, and Maria, the IRS allowed more flexibility for those affected by the storms. Participants affected by the storms can opt for a plan that increases loan amounts to either $100,000 or 100% of the participant’s account balance (whichever number is lower).
In these cases, repayments can also be suspended for one full year.
What if I Leave the Job?
Upon leaving your job, you are expected to immediately pay off your pension loan. Failure to do so may incur a 10% tax penalty in addition to state/federal income taxes.
To make matters worse, you may pay taxes both during loan repayment and after finally tapping into your pension plan upon retirement.
Is a Pension Loan Right for me?
Pension loans are not right for everyone, mostly due to the high fees. In fact, some fees may be so high, that your annual percentage rate (APR) can go over 100%.
Always be sure to have a thorough understanding of which fees to expect, including commissions and if you are expected to take out a life insurance policy. Some lenders require a life insurance policy where they are named as the beneficiary, to assure the pension loan payments continue.
If you decide to obtain a pension loan, research the company and look out for predatory behavior on the part of the company.
What are Alternatives to Pension Loans?
If you are unable to obtain or afford a pension loan, there are certainly alternatives to consider.
- Ask for extra time to repay current debts and loans
- Seek out a credit counselor to receive help
- Consider your local credit union or small loan company, which may offer loans with a lower APR rate
- Consider a cash advance
- Ask your employer for an advance
- Look into government assistance
- If you are in the military, consider a military loan for active and retired military personnel
Always make sure to spend time investigating each option thoroughly.
Pension loans, sometimes called pension advances, can be a way for you to pay off urgent bills or make a large purchase.
However, it’s important to understand the fees, implications on your taxes, and other requirements and deadlines your pension loan requires.
Pension loans are certainly not for every circumstance, and you may even be able to find a cheaper way to get an advance in funds.
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