What Can You Borrow 401k Money for?
401k plans make it very difficult to take an early withdrawal from the plan before you leave the company or turn 59 1/2 years old. However, unlike individual retirement accounts, the Internal Revenue Service permits you to borrow money from your account and then repay it over time without taking a permanent distribution.
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Purpose
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Unlike hardship distributions, the IRS does not require that 401k plan loans be used for any particular purpose. You can use it however you want, such as for a home down payment, child's education or even something frivolous such as a vacation. However, you need to make sure that you understand how the loans work in order to avoid being penalized on your taxes. Also, you do not need to qualify for the loan through a credit score check.
Size
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The IRS does not allow you to take an unlimited amount out of your 401k plan through loans, however. The IRS caps the amount you can borrow at half of your 401k plan account balance, up to a maximum of $50,000. All loans taken from your 401k plan count towards this limit. For example, if you have an outstanding $30,000 loan, the most you could borrow would be $20,000.
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Function
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After taking out a 401k plan loan, you must repay the loan in equal payments, usually over five years. However, the term can be extended if you use the 401k plan loan for your home. The loan charges interest, usually a few points above the prime interest rate. This interest goes back into your 401k plan. As long as you make the repayments as scheduled, you do not report taking out the loan or repayments on your income taxes.
Warnings
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When you take out money from your 401k plan, that money is no longer invested in your account, so any returns you would have earned are lost. In addition, your repayments to the 401k come from after-tax dollars; no tax breaks are given for loan repayments. Finally, if you leave your job, your 401k plan loan must be repaid immediately. If you are unable to repay the loan at that time, the IRS will treat the unpaid balance as a distribution, meaning you will have to pay taxes and penalties.
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