Should I Take a Loan Out of My 401(k)?
The IRS allows employer retirement plans to offer participant loans. This option is unique to employer-sponsored plans such as a 401(k) plan and not permitted in consumer savings plans such as individual retirement accounts. Taking a 401(k) loan gives you access to retirement capital without triggering a taxable event and ultimately losing tax-deferred growth benefits.
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Loan Allowances
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The 401(k) plan is funded by you, and by your employer through matching or non-elective contributions. Your contributions come directly from your earnings. Employer contributions are not yours unless you are vested, which means you have been employed for a defined number of years. The IRS allows you to borrow up to $50,000, but not more than 50 percent of your vested 401(k) balance. If you have $100,000 but only have $80,000 vested, you can only borrow $40,000.
Working With Your Custodian
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You can't take a 401(k) loan out if your custodian doesn't offer the option. While the IRS authorized loan provisions, it is up to each employer to elect the option when establishing the 401(k) plan adoption agreement. If yours doesn't, you have no choice and cannot take a loan. If your custodian offers the loan provision, confirm the limits and terms, as they might not meet the caps established by the IRS. There is no credit check to get the loan. Paperwork is provided by the custodian.
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Repayment of Loans
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You must repay the loan within five years. Payments are taken from paychecks directly. If you leave the job for any reason, the loan is immediately due in full. If you are unable to meet these terms, don't take the loan. If you lose your job and cannot pay the loan back, the balance is considered distributed. Distributions mean taxes and possible early-distribution penalties, creating further financial hardship.
Benefits of the Loan
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If you only need access to part of your 401(k) and don't want to lose your retirement savings, a 401(k) loan is a good option. Review the loan terms to make sure you can make the appropriate payments. The IRS allows multiple loans with the total loan value being the $50,000 or 50 percent. Interest paid on the loan is paid to yourself, but don't expect a tax deduction for the interest; there is none.
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