How to Use Pensions for Collateral Loans

When attempting to secure a collateral loan, it is sometimes possible to make use of the balance in a pension fund as the security for that loan. In many nations, there are restrictions on how and even if a pension can be used as collateral, making it necessary to work with lenders to determine if this is an option. When the balance of the fund can be utilized as collateral, there are normally a series of steps that must be taken to qualify the asset and determine if it meets the criteria established by the lender.

EditSteps

EditDetermining Whether You Can Use Your Pension as Collateral

1. Determine what type of retirement plan you have. Look at any retirement plan documents you have to determine if your plan is a 401(k) or an IRA. If you have an IRA, you cannot use your retirement plan as collateral for a loan. The IRS considers this to be a "prohibited transaction." You also cannot borrow from your IRA. However, if you have a 401(k) you may be able to borrow against your plan.^[1]
   • You may be able to get around this by using a 401(k) transfer to transfer money from your IRA into a 401(k). To do so requires that you have a 401(k) with your employer and that you get the consent of your 401(k) administrator. This may not be possible, depending on your plan.^[2] Consult with a financial professional for more information.
2. Read your pension plan. Even if your retirement plan can allow your funds to be used as collateral, this doesn't mean that they it does. Some plans do allow borrowing, but others don't. Those that do typically only allow borrowing under strict guidelines and limitations. You should always consult with a legal professional to make sure that you are reading and understanding the wording of your retirement plan properly before using it as collateral for a loan.^[3]
   • Some plans only allow you to take out a loan with the plan as collateral if you face certain hardships or meet other criteria.^[4]
   • Many, if not all, plans specify that the loan must be paid back in under five years using equal payments.^[5]
3. Understand who you will be borrowing from. When you take out this type of loan, you will essentially be borrowing from yourself. The money that you are using is the money in your own pension plan. Similarly, any interest paid will be going back to you. Take this into consideration when deciding whether or not to take out a 401(k) loan.^[6]
4. Figure out how much your plan will allow you to borrow. At most, the IRS allows borrowers taking out a loan against their retirement plan to borrow up to $50,000 or 50 percent of their retirement plan, whichever is smaller. This loan must be paid back with interest. If you quit your job before repaying the loan, you must repay the full balance within 60 days.
   • If you fail to repay the loan, and are under the age of 59.5, it becomes an early distribution and you will have to pay income tax and a 10% fee on the value of the loan.^[7]
   • If this amount is less than you need to borrow, you will have to seek other loan options. This loan ceiling cannot be raised.

EditTaking Out Your Loan

1. Fill out the loan application. To get started, you'll have to fill out loan paperwork with your 401(k) plan. This will require you to specify exactly how much you are borrowing and sign a contract promising to pay it back under certain guidelines. Be sure not to sign anything yet, even if you have filled out your loan application completely. You'll need to make absolutely sure that you are filling it out right and understand every provision of the agreement.
2. Have a lawyer look over the loan agreement thoroughly before signing anything. You should have a legal professional examine the loan agreement for any provisions that you may be unaware of and to be sure that the loan is being taken out in a legal fashion.^[8] Have your lawyer explain any contract sections or provisions that you are unsure about.
3. Check to see if the interest can be deducted. In many cases, interest on this type of loan is not tax deductible.^[9] However, in some rare cases, and depending on the loan agreement, your interest may be tax deductible. Consult with you lawyer to determine whether or not this is the case.^[10]
   • If this is the case, you may be able to maximize your returns by paying back a maximum amount of interest on your loan. Consult with a certified public accountant (CPA) for more information.^[11]
4. Be sure to repay the loan. As previously mentioned, failing to repay this type of loan can leave you with several different types of penalties to pay. In addition, you will have less money available for retirement. This type of loan is always required to be paid in full within five years, so keep that in mind when considering your ability to repay the loan.
   • If you are using the loan to purchase a primary residence, however, you may have up to 10 years to pay the loan back.^[12]

EditTips

• Since laws vary, it is important to talk with a legal professional and/or a financial professional about the viability of obtaining a collateral loan with the use of your pension as security. If this option is not available in your jurisdiction, the professional can often recommend other means of obtaining financing.
• While using a pension to secure a collateral loan is 1 option, consider trying other types of collateral or an unsecured loan if at all possible. Doing so minimizes the chances of limiting access to the pension fund during periods of illness or other events that would normally allow some type of lump sum disbursement.

EditRelated wikiHows

• Prepare a Retirement Plan
• Manage Your 401K Investments
• Invest in 401K
• Select an IRA
• Withdraw Roth IRA Contributions

EditSources and Citations

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