Generally, to remain qualified, plans must prevent distributions to employees before death, retirement, termination of service, or retirement.
Borrowing money from a retirement plan is a Prohibited Transaction. The Department of Labor recognized that participant loans are a legitimate investment vehicle, and granted a Prohibited Transaction Exemption for loans to plan participants.
To stem perceived abuses, IRS and DOL have issued rules and regulations which must be followed to prevent participant loans from being considered distributions (taxable income) to borrowers.
A loan from a qualified employer plan will not be treated as a distribution if
Any amount in excess of the limits will be treated as a plan distribution that is subject to taxation. Amounts treated as distributions are still required to be repaid. They become part of your basis once you retire.
Loans are not required to be offered to plan participants, and often times plan loan provisions are less permissive than the above limits.
In 401(k) plans, they are attractive, since an employee can see herself making payments back to her own account.
The Department of Labor has its own loan requirements, concerning the availability of loans to all participants and the selection of interest rates. This section may be fleshed out in response to interest in the subject.
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