Borrowing Against 401(k) Plans

QUESTION: Some of my co-workers and I are indignant over our employer’s refusal to let us borrow from our company 401(k) plans. We keep reading stories about other companies allowing such loans to buy a house or finance a child’s college education, and we have decided it is time to act. We want to be sure our facts are straight, though. Are we right that most companies now offer loans on 401(k) savings? And do you have any idea what the going interest rate is for this type of loan?--C. P.

ANSWER: It is impossible to say whether the majority of all U.S. companies now have loan provisions in their company 401(k) plans. But you would be quoting a reliable source if you used the results of a recent survey by the Hewitt Associates consulting firm of Lincolnshire, Ill. Of the 200 employers Hewitt surveyed, 59% said they now permit employees to borrow money from their 401(k) account at work. That is up from 44% the year before.

Most of those who had recently added loan provisions to their plans cited the Tax Reform Act of 1986 as their motivation.

The new tax law sharply reduced the amount of money an employee can contribute each year to a 401(k)--to $7,000 from $30,000--and removed many tax advantages for millions of Americans who contribute to IRAs.

Employers see the addition of loan provisions to their 401(k) plans as a way to offset some of the setbacks inflicted by the new tax law.

Incidentally, for those who haven’t heard of the 401(k), it is an employer-sponsored retirement savings plan. Employees who participate aren’t taxed on the portion of their salary that they contribute to the plan. Many employers also match their employees’ contributions in cash or stock. Hewitt Associates estimates that fully 89% of all U.S. companies now offer 401(k) plans to employees.

As for the going interest rate charged by those plans that allow loans, Hewitt found that the average for the second quarter of 1987 was 8.6%. But the rates ranged from 4.5% to 12%, and the most popular rates were 7%, 8% and 9%.

Q: I recently came across a column you wrote several months ago that discusses how some parents are paying their children’s college tuition in advance in exchange for a guarantee that the tuition will remain at the same level all four years. I can’t afford to fork over $40,000 in one lump sum. But it got me to thinking whether any colleges will finance students’ tuition themselves so that parents don’t have to scramble to find loans elsewhere. I’ve done some shopping around and I’m finding that banks are very reluctant to make student loans.--B. E.

A: They are in the minority, but some colleges do indeed make their own loans now. These new programs base their loans on the parents’ credit rating, not on their financial need, as was usually the case in the past.

Because the soaring cost of college tuition is one of the reasons for these new loan programs, you will find that the more expensive colleges and universities are in the forefront of this trend.

Stanford, Harvard and Duke, for example, offer one of the most generous loan programs through a private nonprofit institution called Nellie Mae Inc. Parents who qualify can borrow up to $15,000 each year and have up to 20 years to pay back the money at a fixed interest rate of 12%. Variable rates also are available.

Although schools are finding that this can be a lucrative side business, it is also a time-consuming one that many are still reluctant to tackle. So, don’t assume that the college of your children’s choice is in the loan-making business. Check with the school’s administrators as far in advance as you can.

Q: For several years, I have been employed as a temporary worker and I have set aside money each year in an IRA. But at the end of April, I took a permanent job in which there is a company pension plan and was told that I could no longer contribute to my IRA. What happens to the $1,000 I had already contributed to my IRA for 1987 before I took this permanent job? I am single, and my income is under $35,000.--A. T. D.

A: If your earnings were higher, your contribution wouldn’t be tax deductible. As it is, how much of your $1,000 contribution is tax deductible depends on how much less than $35,000 your adjusted gross income is.

Under the new tax law, tax-deductible contributions to an IRA are not permitted from this year on for employees who are “active participants” in an employer-sponsored retirement plan--unless their adjusted gross income is less than $35,000 for singles or $50,000 for couples filing joint returns.

The law defines “active participant” as anyone who was eligible to be in an employer-sponsored retirement plan during any part of the year. So, even though you weren’t covered by an employer’s retirement plan for the first four months of the year, you are eligible to be covered by one now. Hence, your contribution would not be tax-deductible on that basis.

But since your income is less than $35,000--the new law’s cutoff point for singles--you can still get a tax deduction for contributing to your IRA.

Whether your contribution is fully or partly deductible depends on the exact amount of your adjusted gross income.

Singles whose adjusted gross income is $25,000 or less can continue to contribute as much as $2,000 a year to an IRA and get a tax deduction for the full amount. Those with adjusted gross incomes between $25,000 and $35,000 get a partial deduction--of no less than $200--based on a simple formula: Just subtract your adjusted gross income from $35,000 and multiply the result by 20%.

Say your adjusted gross income is $30,000. Subtract that from the $35,000 ceiling and multiply the result, $5,000, by 20%. The result, $1,000, is the tax-deductible amount you can contribute if your adjusted gross income is $30,000.

Married couples do the same, except that they should subtract their adjusted gross income from $50,000 instead of from $35,000. Then they can follow the rest of the formula.