If you have a pension, it might be one of the newer 401(k)s where you participate in investing or an older type where only the company deposits money in your name. Either way, there are rules and regulations established by the IRS regarding using a pension for loan purposes. If you have the right type of plan and provisions within the plan, sometimes you can borrow against your pension.
It is against the IRS code to use a pension as collateral for a loan. In effect, the use gives you constructive receipt of the funds, which means they're available to you. That availability means a taxable incident. Since banks can't use pensions, IRAs or other retirement vehicles as collateral, you wouldn't be able to do this anyhow.
Taking a Loan from the Plan
If you participate in a 401(k), 403B or traditional pensions that have a provision that allows you to borrow from the accumulated amount, you can normally use those funds. However, IRAs, SEPs, SIMPLEs and Keoghs aren't eligible for loans.
The amount you can borrow varies from plan to plan, but in most cases, you can borrow up to 50 percent of the vested amount you have available in the plan, up to $50,000. If your vested amount is less than $50,000, your maximum is 50 percent of the vested amount. Likewise, if $50,000 is less than the vested amount, $50,000 is still the ceiling for the loan.
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If you borrow from a pension plan to purchase a home, and have adequate records to prove that, the interest is deductible. However, if any of the funds were from elective deferrals, the money you put in, that interest isn't deductible. Another exception to the deductibility rule is if you're a key employee. The IRS states a key employee is one who is an officer and whose income is more than $130,000, owns more than 5 percent of the organization or owns more than 1 percent of the organization and whose income is more than $150,000.
For people with a low credit score, often this method of borrowing makes sense. You also pay the interest to yourself rather than a financial institution but do miss investment opportunities.
If you leave employment without paying back the loan in full, you may be subject to a 10 percent penalty and taxation unless you continue to make payments and leave the funds with the company. While you can roll your funds into an IRA or other pension plan, any outstanding loan is a withdrawal according to the IRS and subject to early withdrawal penalties and tax. If you're at least 55 when you part ways with your company, you only pay the tax on the funds.