THE “219” ON ANNUITY LOANS

2 REASONS TO NEVER BORROW FROM YOUR MPP&T ACCOUNT

  1. Borrowing may seem like a good idea, but remember – until you pay the loan back, your money isn’t invested. So, if the market does well the remaining balance of your Money Purchase Plan and Trust won’t experience as much of a gain. Which could possibly result in less money at retirement. And less money at retirement means less retirement income.

  2. Other types of loans – such as a home equity loan – could make more sense. Especially when considering some of the tax advantages that come with that.

    Now you may argue that any money you borrow from the Money Purchase Plan & Trust you don’t have to pay taxes on - that is – as long as you pay it back in a timely manner. I would say you are correct.

    But, and again, you have to pay yourself back in a timely manner! When you don’t, and in accordance with the Internal Revenue Code, the defaulted amount is reported to the Internal Revenue Service as earned income. Which means the defaulted amount is taxable as income in the year that the loan was defaulted. Further, the amount that is defaulted on may throw you into a higher tax bracket for that year.

    Wait there’s more. If you default and are under the age of 59 ½, the Internal Revenue Service will penalize you with an additional ten percent (10%) tax on those defaulted monies. For example, if you are in the 24% tax bracket, and under the age of 59 ½ and default on the loan, you could be taxed upwards of 34% on the defaulted amount.

    Things go from bad to worse when you couple the taxes with the fact that you withdrew these monies and were not able to earn compounded interest year after year on the defaulted amount. Talk about an expensive mistake.

1 SALIENT FACT TO THINK ABOUT WHEN CONSIDERING THAT OPTION.

As a general rule, you should exhaust all other options before considering borrowing from your Money Purchase Plan and Trust. Truthfully, it should be the last option that you should ever consider. If you are thinking about this as an option, remember that:

  1. When you borrow and have to pay yourself back, you do so with after tax monies. Similar to the “cost” mentioned within point #1 and point #2 directly above, there is a cost to paying yourself back. Most people do not realize this. Let me explain. Let’s say you are in the 22% tax bracket. This means that you would only have $0.78 cents after every wage dollar paid to you that would be available for the purpose of repaying yourself back. Said another way, it will take about 22% more work from you in order to make your Money Purchase Plan and Trust account whole again. Therefore:

    a. If you are at the point where you think that it may be a good idea to borrow from your future in order to solve today’s problem, you may want to assess this option from the perspective of what this loan could cost you. Ask yourself if this is the best option available. Could you adjust you budget to solve this issue going forward?

    b. Make certain that the reason why you are borrowing is really a “need” and not a “want”. As described directly above, the financial implications of a default on your future could be significant. For example, you may want a new truck, but do you really need a new truck? Is there a better way to buy or finance that truck without affecting my future retirement?

THE 9 TAKE-AWAYS

  1. If you can avoid it, don’t borrow from your Money Purchase Plan and Trust.
  2. If you do, make certain it is for a good reason.
  3. Bad reasons for borrowing would generally be anything that does not add value, meaning and/or purpose, or anything that could not have waited, been obtained through other legal financial avenues or something that could have been resolved through budgeting.
  4. Don’t lie to yourself about your ability to make the timely scheduled loan repayments. Simply put, if there is any doubt about your ability to make those payments, seriously reconsider the “need” or reason you want to borrow against your future. Remember, defaulting is a costly action.
  5. When thinking about your ability to make timely payments, don’t forget to consider how being laid off, injured, or becoming ill will affect your ability to make those repayments.
  6. If you do borrow, don’t default. As explained earlier, a defaulted loan not only costs more than most think, but, and depending on the defaulted amount, it can also reduce the amount available to borrow in the future and less retirement income.
  7. Bear in mind that every default becomes a withdrawal. Every withdrawal becomes a taxable event.
  8. If you default or did default you can still pay yourself back. Keep in mind that every repayment helps increase the amount of money available at your retirement. The larger that balance, the greater the retirement income you can have.
  9. Lastly, the options to add to your retirement systematically and creatively are greater today, than ever before. And guess what? You don’t have to default on a loan to do so.