How to Borrow Against Your 401(k)
Borrow Against Your 401(k) the Smart Way
by Wes Markham
Borrowing against a 401(k) is something that you should try to avoid unless an emergency arises and you have no other resources to tap into. But as with all things in life, sometimes the unavoidable occurs. Should you need to tap into your retirement funds for a loan, there are certain guidelines you will need to follow.
The Pros of Borrowing against a 401(k)
The biggest advantage of this loan type is that it is easier and quicker than taking out a second home mortgage or a personal loan. Since the funds in your 401(k) are yours, you do not have to fill out a credit application or qualify to receive funds. Because you aren’t borrowing money from a bank, your interest rate will be lower than what you would receive on a personal unsecured loan, which will enable you to pay the loan off quicker.
The Cons of Borrowing against a 401(k)
One of the biggest disadvantages this type of loan contains is that the money you withdraw for the loan will no longer be earning you interest. Even more significantly, you are not allowed to make any contributions into your 401(k) account until the entire loan is repaid. During this time period, you not only lose the accrual of your contributions, but those of your employer as well.
If you ultimately fail to repay the loan, it is considered an ‘early withdrawal’ and you will be subjected to a 10% early withdrawal penalty of the borrowed amount placing you in a higher tax bracket overall for the year.
The Steps
With many 401(k) plans, taking out a loan is as simple as logging into your online account and requesting to have a loan issued. The funds can usually be deposited into your bank account or sent via check in the mail. Unless you’re requesting a loan to purchase a home, most plans will not ask for a reason for the loan.
The Basics of Borrowing
While each plan may have its own specific loan features and restrictions, there are a number of similarities among all 401(k) plans. There are several key points to review before taking out your loan.
- Plans typically have a minimum loan amount which is often $500 or $1,000.
- Most plans allow you to borrow up to 50% of your vested balance up to $50,000 BUT not all plans will allow you to borrow from the vested company match.
- In most cases, your loan must be paid with equal installments taken directly from your paycheck over the life of the loan. This can cause a short-term financial strain because once the loan has been issued, you cannot change the payment terms.
- You may have to pay a fee just to process the loan.
Loans proceeds are not taxed at the time of the distribution, but would be taxed in the event of a default.
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