Should I Take a Loan From My Retirement Plan Account? | American Funds

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TALKING POINTS

Should I Take a Loan From My Retirement Plan Account?

It’s rarely a good idea to dip into retirement savings, but sometimes it’s necessary to take a loan from a retirement plan account. In all circumstances, it’s a decision that should be weighed carefully.
 

Generally speaking, the savings in a retirement plan account should be preserved. But emergencies can arise. If a plan sponsor or participant contacts you for information regarding loans, help them understand the big picture before they decide what to do.

 


 

First Explain That There Are Rules

Not all retirement plans offer loans as an option. For those that do, specifics may vary from plan to plan. Check the plan document for complete details.

Talking points you can use:

  • Loan amounts are limited to half of the participant’s vested balance, up to $50,000.
  • Certain plans may have a minimum loan amount (often $1,000).
  • The interest rate is usually 1% to 2% above the prime rate, which is the interest rate banks charge their best customers. You pay the interest back to your account.
  • Generally, loans must be paid back within five years. Home purchase loans may be extended longer.
  • Some plans may only allow loans for specific uses, such as education expenses, medical expenses, housing costs or the purchase of a first home.
  • Plans may limit the number of outstanding loans a participant can have at one time.
  • There may be loan initiation and maintenance expenses.
  • Participants can pay off a loan early.

 


 

Help Determine if a Loan Is the Best Course of Action

Start a dialogue with the participant or plan sponsor that will help them consider whether a loan is in their best interest.

Talking points you can use:

  • Have them ask themselves what the money is for. If it’s to pay bills or take a vacation, then drawing on retirement money should be a last resort. After all, the money in this account is supposed to help support them in retirement — not today. It really comes down to how comfortable they are choosing the short-term gain of a loan over the long-term cost that could impact them for years when they need the money most.
  • Is there another source of money to meet these current needs? It may be a better idea to consider all resources — family, friends, other accounts, even a traditional bank loan — before dipping into a retirement plan account.

 


 

Describe the Pros and Cons of a Loan

As retirement plan account balances grow, it can become more and more tempting to take a loan. You can build better relationships by explaining the true impact — the potential benefits and disadvantages of loans.

Talking points you can use:

  • Loan benefits
    • Easy access to savings. A participant doesn’t need a credit check or a bank’s approval to apply for it.
    • The loan is not subject to income tax or penalties, as long as plan rules are met.
    • The plan’s interest rates may be lower than what the participant could get at a bank or credit union.
    • Borrow from yourself, pay yourself back. With few exceptions, the payments made on a loan — including interest — are paid back into the participant’s account, not to a bank or someone else. Essentially, the money is returned to the person taking the loan.
  • Loan disadvantages
    • Potentially less money at retirement. Unless the participant subsequently saves more to catch up on missed growth opportunity, he or she may have less to live on in retirement.
    • Many participants tend to reduce their retirement plan contributions while paying back their loans. This can have a long-term impact on their future.
    • There could be an early payback penalty. If a participant with a loan balance leaves his or her employer, the entire balance of the loan must be paid back — usually immediately — or else pay income taxes and possible early withdrawal penalties since it would now be considered a distribution from the retirement plan, rather than a loan.


This material is intended for use by financial professionals or in conjunction with the advice of a financial professional.

Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.