Can you borrow money from your 401(k)?
If you have a decent amount investedand need a short-term loan, you may be considering borrowing from the popular retirement vehicle.
There are many things to consider before taking out a loan from your 401(k), including potential penalties, taxes, and the possibility of a small retirement nest egg.
Before making many important financial decisions, it may be a good idea to consult a financial adviser who can explain the impact to you.
Can you borrow from your 401(k)?
If your plan allows it, you can borrow up to $50,000 or half of your earned balance, whichever is lower, according to the Internal Revenue Service. Many 401(k) plans, which are administered by employers, give borrowers up to five years to repay the loan – with interest.
There is one exception: if your 401(k) has a vested balance of less than $10,000, you can borrow up to $10,000. However, the IRS does not require plans to include this exception, so check with your plan administrator.
You’ll also want to check that borrowing from the 401(k) plan is an option (your plan may require your spouse’s approval). Again, speak with a financial advisor to see if this way of accessing funds is right for you.
Can you borrow from your 401(k) without penalty?
According what your plan allows, you can withdraw up to 50% up to a maximum of $50,000, over a 12-month period. If you repay according to the terms of the loan, you will not be penalized.
But beware: if you lose your job and don’t repay by that year’s tax deadline, the IRS considers your loan a withdrawal. This means that if you are under 59.5 you may have to pay the 10%.
You can also do some rough calculations on early withdrawal costs using a 401(k) calculator.
How to borrow on your 401(k)
You must apply for the 401(k) loan and meet certain requirements, which may depend on the plan administrator. Typically, a 401(k) borrower must repay the loan within five years. Most plans require payments at least quarterly or every three months.
There are a few exceptions – again, it depends on the administrator. For example, if you use the 401(k) loan to purchase a home that will be your primary residence, the five-year repayment requirement may be waived.
Advantages and disadvantages of borrowing from your 401(k)
Expert ratingis the best way to ensure you have funds for retirement. So it’s a good idea to carefully consider the pros and cons of borrowing from your 401(k).
- A 401(k) loan does not trigger a “meaningful” credit check from credit reporting companies and does not appear on your credit report.
- Interest rates are set by the plan administrator and may be lower than other types of loans.
- The interest on the loan goes back to the 401(k). You pay your own account for the loan.
- If you miss a payment on a 401(k) loan, it won’t impact your credit score
- If you use the loan to pay off high-interest credit cards and pay off the 401(k) loan on time, you could reduce the overall amount of interest you pay.
- If you lose your job, you may have to repay the loan in full.
- Likewise, if you lose your job and don’t repay the loan by that year’s tax deadline, the IRS may consider your loan a withdrawal. If you’re under age 59.5, you’ll likely owe a 10% early withdrawal penalty tax.
- You may end up with a smaller retirement nest egg. It’s because investment gain will build on a smaller base while your loan is in progress.
- If you stop contributing to the plan while on loan, you may miss the matching funds offered by some employers.
- A “difficult” withdrawal from your 401(k): There are a few exemptions from the penalties typically associated with withdrawing a 401(k) loan early, although the the requirements are strict. For example, under , you can withdraw up to $100,000 from a pension plan to pay for COVID-19 related issues. Check the terms carefully, as there are often penalties for withdrawing 401(k) funds early and withdrawals can be considered income, which means you will pay taxes.
- Personal loan: If your is good and you have room in your budget for payment, a personal loan may make more sense than dipping into your retirement funds. Learn more about personal loans here.
- Home Equity Loan: If your home is worth more than the current mortgage on the property – known as equity – you might consider this type of borrowing. Typically, home equity loans, or HELOs, have lower interest rates than other loans because your home serves as collateral.