No, generally, you cannot borrow directly from a cash balance plan. While cash balance plans present benefits in the form of a hypothetical account balance, they are legally classified as defined benefit plans, which typically do not permit participant loans.
Understanding Cash Balance Plans and Loans
Cash balance plans are a type of qualified retirement plan that combines characteristics of both defined benefit and defined contribution plans. They provide a benefit that grows annually with a pay credit (e.g., a percentage of salary) and an interest credit, making them appear similar to a 401(k) with an individual account. However, unlike 401(k)s, the investment risk in a cash balance plan is borne by the employer, not the employee. This fundamental difference affects the ability to borrow from the plan.
Why Loans Are Not Typically Allowed
The primary reason cash balance plans do not allow loans is their underlying structure as defined benefit plans. In a true defined contribution plan, like a 401(k) or 403(b), your contributions and investment earnings are held in a separate account in your name. This individual account serves as the source for any loans, with your vested balance acting as collateral.
- Defined Benefit vs. Defined Contribution: Cash balance plans guarantee a specific benefit amount at retirement, whereas defined contribution plans provide benefits based on contributions and investment performance in an individual account.
- Investment Risk: Since the employer manages the investments and guarantees the hypothetical account balance, there isn't a segregated pool of funds for each participant from which a loan could be drawn without affecting the plan's overall funding and the employer's liability.
- Regulatory Framework: The Internal Revenue Service (IRS) regulations governing plan loans are primarily designed for individual account plans (defined contribution plans) where a participant's vested balance can serve as collateral and the loan does not jeopardize the plan's ability to meet future defined benefit obligations.
How Loans Work in Plans That Permit Them
For context, it's useful to understand how loans are typically structured in qualified retirement plans that do allow them, such as 401(k)s or 403(b)s. These plans may permit participants to borrow against their vested account balance, subject to specific limits and rules.
The maximum amount a plan can permit as a loan is the lesser of:
- The greater of $10,000 or 50% of your vested account balance, OR
- $50,000.
For instance, if a participant has a vested account balance of $40,000, the maximum amount that he or she can borrow from the account is $20,000 (50% of $40,000). These loans must typically be repaid within five years, with interest, and payments are usually made via payroll deduction.
It is crucial to remember that these loan provisions apply to plans that are designed to offer them, which generally excludes cash balance plans.
Accessing Funds from a Cash Balance Plan
Since direct loans are not an option, access to funds from a cash balance plan typically occurs through distributions upon a qualifying event, such as:
- Termination of Employment: When you leave the company, you usually become eligible to receive your vested benefit.
- Retirement: Upon reaching the plan's specified retirement age.
- Disability or Death: As per the plan's provisions.
The benefit can often be taken as a lump sum or converted into an annuity, depending on the plan's rules and participant elections. It is always advisable to consult your plan administrator for specific details regarding your cash balance plan's provisions for accessing your benefits.
