Millions of Americans report being just a few hundred dollars short of serious financial hardship.
Can you relate? Are you dealing with a financial hardship right now?
When you’re in the middle of a financial struggle, it’s normal to feel overwhelmed and confused about how to proceed.
The good news, though, is that there are lots of steps you can take to get out of this situation. For example, you can apply for a pension loan.
Read on to learn nine essential things you ought to know about pension loans.
1. What Is a Pension Loan?
When you retire, you may receive a pension from your employer.
This is a sum of money that you have accumulated over several years of working for a particular company. It’s based on several factors, including your total salary and the number of years you spent working for your employer.
A pension loan is a type of high-interest loan that allows you to borrow against the sum of money that makes up your pension.
2. Pension Loans vs Withdrawals
It’s important to understand the difference between a pension loan and a pension withdrawal. It’s easy to assume these two things are synonymous. There are some key differences, though.
When you withdraw money from your pension, you decrease the total amount remaining in your account. You can only make pension withdrawals when you’ve reached retirement age.
If you take out a pension loan, you’re borrowing from your pension before it’s technically yours to have.
Because of this, you have to pay interest on the money you borrow. You’re also responsible for paying back the money by a certain date if you want the event to be considered non-taxable.
3. How Do Pension Loans Work?
Most of the time, when you take out a pension loan, you’re able to borrow half of the vested amount (the amount that you own).
There are a lot of strict policies and rules that you have to abide by when you’re taking out a pension loan. These rules vary depending on the pension loan company with which you’re working.
You’ll first have to research companies in your area to find out which ones are best to work with.
Then, you’ll need to contact them to find out about the details of their contract and how their specific loan process works. They’ll also be able to tell you what the interest rate is for the loan and when you’ll need to repay it.
Keep in mind that your employer might have specific limits on these loans as well. For example, you might only be allowed to take out a loan after working at that company for a specific period of time.
4. Who Is Eligible?
Only certain people are eligible for a pension loan. In order to qualify for this type of loan, you have to be enrolled in a specific type of retirement plan. The following plans qualify for a pension loan:
- Defined benefit pension plans
- 401(k) plans
- 403(b) accounts
- Federal Thrift Savings Plans
- 457 plans
You cannot borrow from an IRA (Roth or Traditional). You also can’t borrow from IRA-based plans, including SIMPLE IRAs and Simplified Employee Pension plans.
5. How Much Can You Borrow?
The IRS limits pension loans (and other retirement loans) to $50,000.
If the total balance of your account is less than this, you’re able to borrow up to 50 percent of the vested benefits or $10,000, whichever amount ends up being greater.
You can take out multiple loans. However, the total amount that you borrow can’t exceed the maximum pension loan limit.
6. When Do You Have to Repay it?
For those who qualify for a pension loan, they have five years to repay the loan. The loan must be repaid in quarterly payments over this period.
Depending on the reasons you have for taking out a pension loan, you may be able to get a longer loan term. For example, this might be the case if you’re using the money to buy a house.
You can also suspend your pension loan payments if you take a leave of absence from your job.
7. Consequences of Missed Payments
If you do not meet the loan repayment agreements laid out by your employer and your lender, the withdrawal from your pension may be considered a taxable transaction.
This means that, along with paying interest on the loan, you also have to pay taxes. You also lose the chance to accrue tax-deferred earnings on the money that you borrowed, and you may face a tax penalty for withdrawing money from your retirement account early.
If you decide to leave your job before you repay the loan, you have less time to repay the loan amount.
8. Benefits of a Pension Loan
When you’re in a tight spot financially, pension loans can be a true godsend.
If you are confident that you can stick to the repayment schedule and pay back the loan on time, too, then there’s not a lot of harm in borrowing against your pension.
As an added bonus, when you’re paying the loan back, you’re paying the money back to yourself instead of to a random lender.
9. Alternatives to a Pension Loan
Of course, a pension loan isn’t for everyone. If you’re not sure you can pay back your loan on time, or you’re worried about some of the other provisions, there are alternatives to consider.
For example, you could look into personal loans (many lenders offer a variety of personal loans, including ones for people with bad credit). You can also try peer-to-peer lending if you don’t qualify for traditional loans.
Apply for Pension Loans Today
Now that you know more about pension loans, do you think applying for one is a good fit for you?
A pension loan does come with its risks, but it can also be very helpful when you’re in a difficult financial situation.
If you want to learn more about other financing options, or if you need help managing your money in general, we have plenty of helpful resources available on our site. Keep tabs on the Economics Basics section!