The CARES Act and 401(k) loans (and other defined contribution plans)
What changed: Many 401(k)s and other defined contribution plans allow participants to take out a plan loan of up to $50,000 or half of their own vested account balance. Typically, loans are then repaid over a five-year period through payroll deductions.
The CARES Act made two big changes as it relates to 401(k) loans.
First, plans now allow a participant to borrow up to 100% of his or her vested account balance or $100,000, whichever is less. These expanded limits only apply to loans made from March 27 to September 23, 2020. Also, remember that not all retirement plans allow for participant loans, it is a decision that is made at the individual plan level.
Second, the CARES Act gives people an extra year to pay back their loans if 2020 was one of the five years for their outstanding loan repayment, essentially creating a six year repayment period with no more payments due in 2020.
The impact: The 401(k) loan amounts expansion and delayed loan payment can provide relief in two meaningful ways.
Borrowing money from your 401(k) for short-term needs is not always ideal, but in a crisis – such as a worldwide pandemic – it can be a better strategy than taking out personal loans or credit card debt. The benefit of a 401(k) loan is that while you owe interest on the loan, it pays back into your own retirement account. You don’t have to pay someone else to borrow your money, you pay yourself to borrow money.
Loan funds are not taxable as ordinary income when they come out of the plan and can be repaid, whereas normal distributions are taxable and typically cannot be put back into the plan easily.
Second, granting individuals another year for 401(k) loan repayments means they don’t have to remove money from their paycheck. This allows for higher cash flow and paychecks for the rest of the year.
It’s a good idea to contact your employer and retirement plan provider to make sure you can push off your loan payment. It is unlikely most plans and employers will make the suspension of 2020 payments an automatic feature so it is up to the individual to request.