Borrowing money from a 401(k) is a common strategy used to get through hard times. Show
There are some perks to it, including the fact that you don't need good credit to qualify for a 401(k) loan and you pay interest to yourself instead of a creditor. Some Americans decide these advantages outweigh the considerable downsides such as passing up potential investment gains on the borrowed money. If you're in the process of deciding whether borrowing from your retirement account makes sense, here are seven things you need to know. 1. You can borrow up to $50,000 or 50% of your vested balanceA 401(k) loan is limited to the lesser of $50,000 or 50% of your vested balance. Of course, you can only borrow as much as you have available in your 401(k), so if your balance is smaller, you won't be able to take out a loan for the full allowable amount. 2. You typically have five years to repay the loanA 401(k) loan must be repaid within five years of borrowing the money from your account. Repaying the loan on schedule is crucial to avoid early filing penalties and other tax consequences, which are discussed below. 3. Not all 401(k) plans will allow you to borrowNot all 401(k) plans allow you to borrow against your retirement account. If your employer doesn't permit it, you won't have this option available. You'll need to check with your plan administrator to see if you're allowed to borrow and what the maximum loan limits are. 4. If you lose your job, you may have to repay the money by tax day next yearLeaving your job used to trigger a requirement that you repay your loan within 60 days. However, the rules changed in 2018 under the Tax Cuts and Jobs Act. Now you have until tax day for the year you took the withdrawal to pay what you owe. So, if you borrow in 2021, you will need to repay the full balance by April 15, 2022, or by Oct. 17, 2022, if you apply for an extension. If you borrow in 2022, you'll have to repay the full balance by April 17, 2023, because April 15 of that year falls on a Saturday, or by Oct. 16, 2022, since the 15th of October falls on a Sunday. This longer deadline does slightly reduce the risks of borrowing. But, if you take out a loan now, spend the money, and then are faced with an unexpected job loss, it could be hard to repay your loan in full. 5. If you default on your 401(k) loan, you'll owe a penaltyIf you do not pay your 401(k) loan back as required, the defaulted loan is considered a withdrawal or distribution and thus is subject to a 10% penalty applicable to early withdrawals made before age 59 1/2. That's potentially a huge cost, especially when you also consider the loss of the potential gains your money would have made had you left it invested. 6. If you take a 401(k) loan, you'll pay interest to yourselfWhen you borrow against your 401(k), you have to pay interest on your loan. The good news is that you'll be paying that interest to yourself. Your plan administrator will determine the interest rate, which is usually based on the current prime rate. The bad news is that you will pay interest on your 401(k) loan with after-tax dollars. When you take money out as a retiree, you are still taxed on the distributions at your ordinary income tax rate. This means the money is effectively taxed twice -- once when you earn it before using it to pay back your loan and then again when the withdrawal is made. The interest you pay yourself is generally also below what you would earn if you had left your money invested. 7. 401(k) withdrawals are an alternative to 401(k) loansA 401(k) loan is generally preferable to a 401(k) withdrawal if you must use the funds in your retirement accounts to meet your immediate needs. A loan is a better alternative because:
Before considering a 401(k) withdrawal and incurring both the penalties and losing gains for the remainder of the time until retirement, you should seriously think about taking out a loan instead if your plan allows it. Weigh the pros and cons before you take out a 401(k) loanAlways carefully consider the pros and cons before you borrow against your retirement account. Your financial future is at stake when you withdraw invested funds that should be helping you build security in your later years. Related retirement topicsThe Motley Fool has a disclosure policy. If you are pressed for cash, you may consider borrowing from your 401(k) instead of taking a bank loan. Although not all employers allow 401(k) loans, you should check with your plan to see if it allows 401(k) loans. You can borrow 50% of your vested balance up to $50,000. Some 401(k) plans allow participants to borrow more than one loan as long as the total amount borrowed is within the IRS limit. If you have an existing 401(k) loan, you can take another 401(k) loan at any time based on the highest outstanding balance in the previous 12 months. However, if you have exhausted your 401(k) loan limit, you must wait until the lapse of the 12-month rolling period to take a second loan. For example, if you took the loan in December, you must wait until the following year’s December to take a second 401(k) loan. IRS 401(k) RulesThe IRS allows 401(k) plans to give loans to the plan participants but based on certain rules. One of these rules is that 401(k) participants cannot borrow more than half their vested balance or $50,000, whichever is less. For example, if you have a vested 40(k) balance of $200,000, half of this account balance is $100,000. However, since this amount exceeds the maximum allowed 401(k) loan, you can only borrow up to $50,000. Usually, participants must pay off the entire loan within 5 years, except in limited circumstances such as borrowing to buy a home where you may be allowed a longer repayment period. Although the IRS sets the 401(k) loan rules, the 401(k) plan may have its own rules on 401(k) loans. The plan may fix a lower 401(k) loan limit, limit borrowing to one loan for each period, or even choose not to allow 401(k) loans. 401(k) loan limitThe IRS allows participants to borrow the lower of 50% of the vested account balance or a maximum of $50,000. If you have an existing 401(k) loan that you are still paying, you may be allowed to take a second loan as long as the total of both loans does not exceed the IRS loan limit. The IRS places limitations on the amount you can borrow on a 12-month rolling period, even if you repay the entire first loan within the 12-month period. How Much Can You Borrow as a second 401(k) loan?If your 401(k) plan allows multiple 401(k) loans, and you have an existing 401(k) loan, you must figure out how much you may be allowed to borrow as a second loan. Generally, the second 401(k) loan will depend on the highest outstanding balance in the previous 12-months, regardless of how much you have paid in loan payments. Start by calculating the difference between the highest 401(k) loan balance in the last 12-months, and the 401(k) loan balance on the date you want to take a second loan. Deduct the result you get from the maximum 401(k) loan you can borrow from your 401(k) loan. Then, subtract the 401(k) loan balance on the date you want to borrow a second loan to find how much you can borrow. For example, if your vested balance of $120,000, it means you can borrow up to the IRS limit of $50,000. If the current loan balance is $20,000, and the highest outstanding loan balance in the last 12 months was $28,000, the difference between the two values is $8,000. Deduct $8,000 from the $50,000 to get $42,000. Then, deduct current loan balance of $20,000 from $42,000 to get $22,000. Therefore, $22,000 is the amount you can borrow as a second 401(k) loan. 401(k) Repayment Terms401(k) plans require participants to make loan payments at least quarterly over the defined repayment period, usually 5 years. The repayment period could be higher if you are borrowing to buy your primary residence. Most of the time, the plan may require borrowers to repay the loan through payroll deductions. If you opt out of payroll deductions, you will be responsible for making loan payments based on the plan’s repayment schedule. If you leave your job with an unpaid 401(k) loan, you will have to pay off the outstanding balance before the following year’s tax due date. However, if you are unable to pay the loan within the required timeframe, the unpaid loan will be considered a deemed distribution, and you will owe income taxes and a potential 10% tax penalty if you are younger than 59 ½. Can You Borrow From an Old 401(k)? If you have an old 401(k), we can help you unlock your retirement money, so that you can take a 401(k) loan for your financial emergency. A 401(k) loan
has a quick approval process, and you can get approved almost immediately if you have sufficient balance to qualify for a 401(k) loan. The 401(k) loan comes at zero net interest, and you can borrow even with bad credit. How soon can I borrow from my 401k?If you have an existing 401(k) loan, you can take another 401(k) loan at any time based on the highest outstanding balance in the previous 12 months. However, if you have exhausted your 401(k) loan limit, you must wait until the lapse of the 12-month rolling period to take a second loan.
How do I get a loan from my 401k?Steps to Get a 401(k) Loan. Talk to Your Employer About Loans from Your 401(k) Plan. Find out if your employer allows 401(k) loans. ... . Learn About the Terms. ... . Fill out the Required Paperwork. ... . Receive the Loan. ... . Make Regular Payments on the Loan. ... . Keep Making Regular Retirement Plan Contributions.. Does my employer have to approve my 401k loan?The 401(k) plan administrator is responsible for approving 401(k) loans. Once you send your loan application, the plan administrator must review the application to determine if you qualify to borrow against your retirement savings.
Can you be denied for a 401k loan?A 401(k) plan could deny your 401(k) loan request for various reasons. Your 401(k) loan could be denied because you are nearing retirement, your job will be scrapped off in a restructuring process, or if you have exceeded the loan limit. If your 401(k) loan was denied, you should find out why it was denied.
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