Can you borrow from your pension

By Matt Mayerle
Modified on June 7, 2023
Can You Borrow From Your Pension

It is never too early or too late to start planning and investing in your financial future. Preparing for retirement is necessary if you want to live comfortably once you stop working. There is an abundance of ways in which you can financially prepare for your retirement, from an individual retirement savings account to a pension fund and beyond. 

Pension plans are incredibly popular for retirement planning as they are convenient and don’t take much effort to build substantial savings. One benefit of pension plans that many individuals choose to take advantage of is the possibility to borrow money from their savings through a pension loan.

How Does a Pension Plan Work?

The use of a pension plan is so widely relied on as a method of retirement saving because it requires an employer to pool funds on an employee’s behalf, making it easier to build a substantial savings with minimal effort.

In a traditional pension plan, the employer places regular contributions towards a pool of money that will fund regular pension payments when the employee retires. Pension plans are becoming less common nowadays, often replaced by retirement plans that cost employers less money, like 401(k) retirement plans. Still, there are plenty of workers in the United States that are currently covered by a pension retirement plan.

What Are Pension Loans? 

Most people have heard of an advance on your paycheck, but not as many people are aware of the possibility of a pension advance. It is not possible to get a loan or advance from every type of retirement account, but there are several with which it is possible.

While you cannot borrow from traditional Individual Retirement Accounts (IRAs), employers have the ability to include loan provisions in pensions within the parameters of 401(a), 403(b), and 403(b) plans.

However, employers are not required to provide loan provisions in their pension plans. The Internal Revenue Service (IRS) allows it, but that does not mean pension loans will be possible with every plan.

Pension Loan Limits

According to the IRS, it is possible for individuals to borrow up to $50,000 in a pension loan. Even though that is technically the maximum loan limit, you cannot borrow more than 50% of your vested balance, which might be significantly less. Your vested balance is comprised of the money you deposited through payroll deductions, investment earnings, and the portion of your employer’s contributions that belong to you.

It can take a substantial amount of time before your employer’s contributions belong to you. According to federal vesting rules, it can take up to seven years before the deposits of your employer become fully vested.

To obtain a pension loan, you will need to complete a loan application to see what loan amount you qualify for and what your interest rate will be.

Repaying the Loan

Before taking money out of your pension through a loan, read over the payment terms closely. The IRS does not allow repayment periods longer than five years. The loan payments necessary to handle the repayment amount in less than five years might be outside your budget which is why it is crucial to make a decision like this carefully.

If you are not able to make the scheduled loan payments to handle the loan balance in full, you may need to pay taxes on the money you’ve taken from your pension account. 

Alternate Ways Of Accessing Retirement Savings

When pension loans aren’t an option, there might be other alternatives for accessing your retirement savings early. You might also want to consider hardship distributions or 401(k) loans.

Pension Hardship Distribution

Instead of borrowing money from your pension through a loan, you could simply withdraw funds early. Some pension plans allow for a hardship distribution under certain circumstances. Hardship distributions will enable you to withdraw funds without penalty. To qualify, you must have immediate and financial need.

While a hardship withdrawal will not be subject to a penalty, it will be a taxable distribution. You will still need to pay federal income tax on the money you take out of your pension early due to financial hardship. 

401(k) Loans

Similar to more traditional pension plans, you can also borrow money through a 401(k) plan. Depending on your situation and how much money you have built up, a 401(k) plan could be a better option for your particular needs. 

The Dangers of Accessing Your Retirement Savings Early

Borrowing money from your retirement savings can pose several risks that you should be aware of beforehand. If you were to change jobs, you would need to immediately pay the outstanding balance on any loans you have taken out. 

Additionally, the outstanding loan amount will be subject to federal income tax if you do not repay the loan. On top of that, your monthly payment on your loan is deducted from your salary on an after-tax basis. Therefore, you end up paying taxes on the same funds twice since you need to pay taxes on the money when you make your final withdrawal.

Other Options for Borrowing Money

If you determine that it might not be the best idea to obtain borrowed money through your pension plan, there are still plenty of options that you may be able to rely on to get the funding you need. 

There are a wide variety of loan options for you to borrow money. You can find the repayment period and eligibility requirements that fit for you based on your financial situation and unique needs. 

Here are a few of the common alternatives to pension loans:

Loans From a Bank or Credit Union

If you are in need of a loan and have a good credit history, getting a traditional loan from your local bank or credit union could be an excellent solution for you. The loan application process may take a little longer than an online loan, but you may be able to access competitive interest rates if you have decent credit. 

You could work with the loan agents to get a repayment period that works well for your budget without risking any of the savings that you have set aside for your future. 

A VA Loan

If you happen to be a veteran, it could be possible for you to get a loan from the Veterans Administration (VA) using your pension as collateral. This could allow you to keep your pension funds where they are so they can keep accruing interest while still getting the loan you need. 

Additionally, a majority of pension holders are public employees, which may mean that you have access to a credit union as one of your employee benefits. As we mentioned above, a credit union may get you a good deal on a loan without needing to dip into your savings. 

Home Equity Line of Credit

Another popular lending option that may be an excellent solution is a home equity line of credit. A home equity line of credit (HELOC) or home equity loan allows homeowners to borrow money at competitive interest rates using the equity value built up in their home as collateral. The loan interest of HELOCs is tax deductible making them smarter financial decisions for many borrowers.

With a pension loan, you may not have a vested balance large enough to obtain the loan amount you need. A major benefit of a home equity loan is that depending on the value built up in your home, you might be able to get a substantially larger loan amount at much lower interest rates. 

Online Personal Loans

Personal loans from online lenders can provide you with money quickly and can be a great idea when you have an emergency expense with few options available to you. Personal loans are typically unsecured, meaning they can have higher interest rates, especially if you don’t have a very good credit score. 

Products like payday loans for bad credit are available to people with poor credit but they should only be relied upon as a last resort option. These kinds of loans are incredibly costly and have short repayment periods making them challenging to pay off on time. We recommend only taking out short-term loans like these after reviewing all your options and ensuring that you can afford to pay off the loan in a timely manner.

Once the loan balance has been repaid, move quickly to build your own emergency fund. Starting an emergency fund is one of the best financial decisions you can make as it will protect you from needing to take on further debt in the future or dipping into your retirement savings to cover unexpected expenses.

Can I Borrow Money Against My Pension?
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