Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: SUNDAY, March 9, 1990 TAG: 9003092364
SECTION: BUSINESS PAGE: B-7 EDITION: METRO
SOURCE: MARY ROWLAND THE NEW YORK TIMES
DATELINE: LENGTH: Medium
What many do not know is that it also can be the source of a loan to make a down payment on a home, buy a car, take a vacation or to satisfy just about any other need you may have for ready cash.
There are several big advantages to 401(k) plans, which are offered through employers.
They allow you to tuck away pre-tax dollars for retirement, the earnings grow tax deferred and part of the money you contribute may be matched by your employer.
The disadvantage is that money withdrawn before you turn 59 1/2 is subject to tax and a 10 percent penalty on the amount you withdraw.
A year ago, when the Internal Revenue Service issued tough new guidelines on early withdrawals - limiting them to situations of extreme hardship - many plan participants assumed they could not touch their money until retirement.
But loans are available at about 65 percent of the employers that offer 401(k) plans and can generally be made for any reason, according to Richard Koski at Buck Consultants, a New York-based benefits consultant.
He said more companies were adding loan provisions because it makes the plans more attractive, particularly to lower-paid employees who may be reluctant to lock up their money.
This is of particular concern for companies that want to reward high-level employees by offering 401(k) plans; by law, lower-paid employees also must participate.
There are several advantages to tapping your 401(k) for a loan rather than going to a bank.
First off, you qualify for a loan simply by having money in the plan.
Second, the interest you pay goes into your retirement account.
"The interest becomes part of the employee's plan rather than going to a bank," says Karen Frost at Hewitt Associates, an employee benefits consultant based in Lincolnshire, Ill.
Although most of the rules governing plan loans are set by individual employers, the loans are also affected by some Department of Labor rules effective last October and some rules established by the IRS.
To avoid being taxed on the money, employees can borrow no more than 50 percent of the money in their plan up to a maximum of $50,000, according to Douglas J. Tormey at Towers Perrin, a New York-based employee benefits consultant.
The money must be repaid within five years unless it is a loan for a home, in which case the term is set by the employer.
The most common term for a 401(k) home loan is 10 years, according to Frost, but some can run up to 30 years.
Although the employer sets the interest rate, the recent Department of Labor rules prohibit loans offering a below-market interest rate, Tormey said.
As a result, most employers tie their interest rate to the prime rate, the base rate on corporate loans at large money-center banks.
A soon-to-be-released study by Buck Consultants found that 60.8 percent of employers determine their rate by using either the prime rate or the prime rate plus or minus a number of points.
The prime rate is now 10 percent, compared with current bank consumer-loan rates of about 13 percent.
Further, in 401(k) loans, the rate is fixed, unlike some consumer and home equity loans, which have adjustable rates.
But the interest rate should not be your most important consideration because, after all, you are paying the money into your own account.
What you should consider is how long you are likely to stay at your current job.
Most plans do not allow you to continue your repayment schedule if you leave the company, Frost said.
That means that you must pay back the outstanding balance if you leave - whether you quit or are dismissed, for whatever reason.
If you do not pay back the entire balance, it will be considered a taxable distribution and you must pay tax and the 10 percent penalty on it that year.
While the government rules set a maximum loan amount, most employers also set a minimum amount because of the administrative costs of making loans.
In fact, the Buck survey found that only 6.2 percent set no minimum.
The vast majority - 61.2 percent - set the minimum at $1,000 to $1,499; another 28.2 percent allowed employees to borrow a minimum of $500 to $999.
The procedure is simple. You go into your personnel office and ask for a loan.
It may take about a month to receive the check. You repay the money by payroll deductions.
Although a few companies will allow employees to decide which plan assets they will sell in order to borrow money, most take a proportionate amount from each investment you have, Tormey says.
The interest on a 401(k) loan is considered consumer interest and only 10 percent of it is deductible on 1990 taxes; next year, none of it will be.
And there's no requirement for the plan to provide an annual statement of that interest, Frost said, "so you should keep track of it yourself, if you want to know."
by CNB