Plan Loans

April 13, 2006

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It's your decision whether to allow plan participants to borrow from the retirement plan. You don't have to allow loans if you don't want to. If you do, though, you should keep in mind that a loan will be considered a distribution (with dire tax consequences) if the rules aren't followed.

The key rules to follow are to make sure that the loan:

bears a reasonable rate of interest (i.e., at least equal to the prime rate)
is adequately secured
is made in accordance with your plan document
provides a reasonable repayment schedule
is made available on a basis that does not discriminate in favor of employees who are officers, shareholders, or highly compensated individuals

If you allow loans, you also have a choice of whether to allow loans only against the funds in that employee's account or against the full plan value. As a small employer, you're probably much better off limiting the loans only to the funds in that employee's account because a loan default could be particularly crippling to your other participants.

Loan amount. Most plans restrict the loan amount to no more than one-half of the employee's vested account or benefit.