Can I Borrow From My 401k Plan?
Taking a loan from your 401K plan is helpful when done carefully, but there are many limits. Early withdrawal has penalties and contributions will have to be repayed to replenish your retirement plan.
A 401k plan is a retirement option provided by many employers that allows you to make pre-tax contributions taken out of your salary. Most of the employers also provide a matching incentive, which means they also contribute the matching amount of whatever your put into your retirement account. However, there are vesting rules that regulate when those matching amounts become fully yours. These policies are different for each employer and usually specify the number of years you must be employed by the company to fully own your retirement plan.
It's also possible to borrow from your 401k plan. However, there are a few things you need to know about before you decide to.
Borrowing from Your 401k Plan
The maximum amount you can borrow from your 401k plan is either 50 percent of the holdings or $50,000, whichever is less. The great thing about this loan is that there is no credit check required, because you're essentially borrowing from yourself. This is a great feature that comes in very handy during times when it's almost impossible to obtain a loan unless you have a near-perfect credit score. The interest rate, which is prime plus 1 percent most of the time, is set by your employer. The repayment term, which is also set by your company, is usually 10 years. However, when you borrow for a mortgage down payment, the term can be expanded to 30 years.
Repaying the Loan to Your 401k Plan
Once you have taken a loan from your 401k plan, you have reduced the sum available to you after retirement. The repayment amounts will be deducted from your paycheck from after-tax earnings. Also, your employer might post limitations on your 401k contributions or stop them altogether until you fully repay the loan, which means you'll have less money saved for retirement.
Failure to Pay Off Your Loan
If you fail to pay off your entire loan until you are 59 1/2, the IRS will impose a penalty of 10 percent plus the regular income tax on the entire amount borrowed.
Getting Laid Off or Switching Jobs
If you are laid off or quit, you have 30 to 60 days to pay off the loan. Otherwise, the 10 percent penalty and income tax payment apply. If you quit your current job to take a position in another company, the same repayment rules apply as if you were laid off.
Because borrowing from your 401k plan might become troublesome and limit your income at retirement, you should carefully consider this option. This loan should not be used for day-to-day purchases or for a vacation. A mortgage down payment or an extreme emergency could be the possible reasons for borrowing, but in either case you should consult with your financial planner first.