Although in the past it was generally considered unwise to pull money from a personal retirement plan, this is becoming more and more common. The growing tendency to take out loans on benefits plans is a result of both financial pressures making people feel they have no other choice and the belief that retirement no longer holds the security it once did. The two common types of benefit plans are defined benefits plans and defined contributions plans. Each plan has its own stipulations for taking out loans.
A defined benefits plan accrues money for a person regardless of what kind of profit he or she makes in any given year. It works according to a fixed formula and is funded by the employer. Defined contribution plans, on the other hand, entail the individuals on the plan contributing a fixed amount of money to their accounts on an annual basis. Whereas workers on a defined benefits plan will have met their desired retirement benefits, workers on a defined contributions plan may come up short or may retire with more money than expected.
There are two fundamental types of loans on benefits plans: secured and unsecured. A secured loan requires the individual to put up some sort of collateral — generally a house or car. Using assets such as these as collateral serves as a security measure. Lenders are more likely to get their money back when they are holding something of value. If they don’t get their money back through loan payments, they are still holding valuable assets that they might be able to sell to regain their money.
This practice poses a threat to most people. Risking a home does not sit comfortably with anyone, but it has its benefits. Secured loans on benefits allow for more money to be lent and for payments to be made over a longer time frame with lower interest.
The other principal loans on benefits plan is an unsecured loan, which features the advantage of not risking a major piece of personal property. No collateral is required, and the loan essentially works on the basis of an individual’s guarantee to repay it. This means that not just anyone will qualify. A co-signer may be required and a bad credit report may cause the loan to be denied. If workers do receive approval for unsecured loans, they will not be able to borrow as much as they would on a secured loan, and the interest rates will be higher, with a smaller interval of time in which to make payments.
It should be noted that loans on benefits plans may vary according to an employer’s or individual’s plan. Certain plans, for example, may specify that a loan can only be taken out in the event of some hardship, such as funding education, buying a home, or paying medical bills. It is also important to note that while an employee may be able to take out a loan on a benefits plan, it is not always the best choice, and all financial possibilities should be explored.