July 13, 2008 - I have a significant amount of money in a company retirement plan, and would like to access the funds to make some large repairs to my home. Can I do that without triggering taxes?

The ongoing housing and mortgage market mess, struggling stock market and uncertain economic climate, mean tough times for cash-strapped individuals looking to borrow money for such things as paying for a child's college tuition, financing a much-needed home repair, or simply keeping up mortgage payments while the family goes through a rough patch, like a spouse's unemployment. Compounding the misery is the fact that many people have locked away the lion's share of their savings in a tax-favored retirement vehicle, like a company profit-sharing or 401(k) plan, IRA, or Roth IRA. And getting at that money to solve a pressing financial crisis isn't easy.

Borrowing from a company retirement plan that permits loans usually is quick, can be requested for any reason, doesn't affect a person's credit rating, and often will cost less than a bank loan (typically the interest rate will be prime plus 1%). What is more, the interest paid on the loan will be funneled back into the plan participant's account (and continue to grow on a tax-deferred basis until withdrawals commence) instead of being paid to a lender. Finally, the loan won't have any tax consequences if it is set up properly.

A loan to a participant in a qualified employer plan won't be treated as a deemed (taxable) distribution if it satisfies the following loan amount, loan term, repayment, and documentation requirements.

Loan Amount. The loan amount can't exceed the lesser of (1) $50,000, or (2) 1/2 of the present value of the employee's nonforfeitable accrued benefit under the plan. But a loan up to $10,000 is allowed, even if it's more than half the employee's accrued benefit. If a plan loan (when added to the employee's outstanding balance of all other plan loans) exceeds these limits, the excess is treated (and taxed) as a plan distribution.

Loan term and repayment. The plan loan generally must be repaid within five years in substantially level payments, made not less frequently than quarterly, over the term of the loan. The level amortization requirement doesn't apply while the borrower is on a leave of absence not lasting more than one year (longer, if for military service, see below), and either not receiving pay or receiving pay at a rate that's less than the installments required under the loan. However, the loan (plus the interest that accrues during the leave) still must be repaid by the end of the loan term.

If a plan suspends loan repayments while the borrower is performing military service, the repayment period is tolled during that service. When the participant returns, the loan must be repaid over the latest permissible loan term plus the term of the suspension period.

Documentation requirements. The plan loan must be evidenced by a legally enforceable written agreement with terms that demonstrate compliance with the requirements for non-distribution treatment, specifying the amount and date of the loan, and the repayment schedule.

For a plan loan which is not treated as a distribution, no deduction is allowed for interest paid or accrued during the period: (1) on or after the first day on which the individual to whom the loan is made is a key employee (e.g., an officer making more than $150,000 for 2008, or a 5% company owner), or (2) the loan is secured by amounts attributable to elective deferrals under a qualified cash or deferred arrangement (CODA) or under a tax-sheltered annuity.

A plan loan that is in default is generally treated as a deemed distribution. Where the plan provides for a grace period (e.g., borrower has until the end of the calendar quarter following the quarter in which the repayment was missed to make up missed payments) a loan default won't become a deemed distribution until that grace period expires without the default being remedied. For example, where a plan allows a cure period through the end of the next calendar quarter, if the quarterly payments are due at the end of each calendar quarter, and the participant made the March payment but missed the June payment, the loan would be in default as of the end of June, and the loan would be treated as a distribution at the end of September.

A deemed distribution is treated as an actual distribution for purposes of determining the tax on the distribution, including the 10% premature penalty tax that may apply. A deemed distribution also is subject to withholding and information reporting.

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