Personal Loans

401(k) Loan: How It Works and How to Get One

401k loan

A 401(k) loan allows you to access the money you have saved in your 401(k) retirement account. But even if you have a sizable retirement fund saved up, there are notable drawbacks to this type of loan.

Here’s what you should know about 401(k) loans.

How does a 401(k) loan work?

When you take out a 401(k) loan, you’re borrowing from your own retirement savings rather than from a lender. Because of this, they’re typically easier to get for people with bad credit – since there’s no credit check to qualify – and the interest rates tend to be low.

But not all plans permit you to take out a loan against your retirement savings. For those that do, there are certain 401(k) loan rules you need to be aware of.

  1. Withdrawal limits: The maximum amount you can borrow from your 401(k) is $50,000 or half of the vested amount, whichever is less. Some plans also have a minimum amount you have to withdraw. If you had an outstanding loan from the plan during the one-year period before you take out your new loan, the maximum amount you can withdraw will be reduced.
  2. Loan term limits: The longest you’ll have to pay back a 401(k) loan is 5 years, but you may be able to choose a shorter term if it meets your needs. There’s also an exception for borrowers looking to finance a down payment on a home.
  3. Potential requirement for spousal approval: Some plans require married folks to show written evidence of spousal approval to take out a 401(k) loan.
  4. Tax implications: Repayments are typically made directly from your paycheck after taxes, and you’ll also pay taxes when you withdraw that money again after you retire.
  5. Inherent risks: If your employment is terminated before you’ve paid back the loan, you’ll likely be required to pay off the balance within 90 days. Otherwise, you’ll pay income taxes on the amount you borrowed. And you might be subject to an early withdrawal penalty of an additional 10%, if you’re younger than 59½.

How to get a 401(k) loan

The process of obtaining a 401(k) loan will vary depending on your plan provider. But since there’s typically no credit check required, you can request information about the rates and fees associated with a 401(k) loan without hurting your credit score. Here’s how to initiate the process.

  1. Review your plan documents. Not all plans allow 401(k) loans, so make sure they are available through your provider by reviewing your plan documents. These may be available on an online account or you may have to request them by mail or from your Human Resources department. Also look for information such as:
    1. Minimum and maximum dollar amount
    2. Maximum number of outstanding loans
    3. Repayment terms
    4. APR
    5. How repayments are collected
  2. Decide how much you need to borrow. Make sure that this amount falls within the limits set by the IRS and your provider.
  3. Determine your budget for your payments. Add up your monthly expenses. Can you make your payments on time while still keeping up necessary expenses like rent and utility bills? If not, you may need to borrow from another source over a longer term or secure additional income.
  4. Apply for the loan. If you’re ready to pull the trigger, complete the application process set forth by your provider. You may be able to complete the application online, or you may have to fill out paperwork with your Human Resources department.
  5. Get approved. Once your request is approved, you should be able to access your cash in just a few days.

If you’re not sure if a 401(k) loan is right for you, you’ve got nothing to lose by requesting additional information from your provider. You can compare rates with those offered on personal loans or secured loans like a home equity loan to decide your best move. Just make sure you can keep up with the payments before you decide to apply for any loan.

FAQs: 401(k) loans

Interest rates vary by plan provider, but the typical interest rate is the prime rate plus 1%.

That depends on the application process for your plan provider. An online application may be quicker than paperwork that needs to be passed on through HR. However, once your application is approved, you’ll typically be able to access your money in a few days.

Since your provider can’t discriminate against you when choosing whether to provide you with a loan, there are only a couple of situations in which you might be denied. If you request a loan that is not permitted based on your provider’s rules, or if you inform your provider that you don’t plan to repay the loan, then you can be denied for a 401(k) loan.

No. The IRS does not allow loans to be taken from IRAs or IRA-based plans. However, once per year, you are allowed to take money from an IRA and move it to another retirement account within 60 days without paying taxes or penalties. In some emergency situations, this can act as a short-term loan.

Generally speaking, it’s only smart to borrow money when you need to finance a purchase such as a home or vehicle. You should have an emergency fund to cover unexpected expenses and secure additional income if you’re not able to make ends meet. That said, many people are unprepared for an emergency, and if other sources charge much higher interest rates or you have no other options besides bankruptcy, a 401(k) loan may be a good option.

Alternatives to a 401(k) loan

Temporarily stop contributing to your 401(k)

You may be able to cover a small unexpected expense just by pausing your contributions, since you’ll have more income from your paycheck. However, you shouldn’t view this as a long-term solution, since it’s important to save for retirement.

Consider a 401(k) withdrawal

Some providers will allow you to take an early withdrawal if you demonstrate that you have an emergency financial need. Circumstances can include, but may not be limited to, the following:

  • Medical care expenses
  • Costs of purchasing your principal residence (excluding mortgage payments)
  • Tuition and other educational fees for you, your spouse or your dependents
  • Eviction or foreclosure prevention costs
  • Funeral expenses
  • Damage repair expenses on your principal residence

The withdrawal amount will be limited to what is needed to cover the expense. While you don’t have to repay a 401(k) hardship withdrawal, you’ll lose the money from your retirement account, and you may be taxed at 10%.

Get a side hustle or second job

Securing additional income is the best way to make sure you can cover your expenses. Luckily, there are many side hustles, from driving for a ride-sharing company to walking dogs, that you can pick up quickly and easily. Some side gigs do not require prior experience.

Ask friends or family for help

If you have a friend or family member that can help you financially in an emergency, explain your situation and your plan to repay them. It can be tough to ask for help, but this is usually the cheapest option for borrowing money.

Seek out a personal loan

If you have good credit and aren’t carrying a lot of debt, taking out a personal loan may be preferable to borrowing from your 401(k). That’s because you may be eligible for a lower interest rate and flexible terms. Because personal loans are unsecured, you don’t need collateral to qualify.

Using LendingTree and depending on your eligibility, you may be able to see and compare personalized rates quickly and easily without impacting your credit. You’ll just need to complete a simple online form to see terms from up to five lenders.

Bottom line

If you’re considering taking out a 401(k) loan, you should make sure you understand all the fees, rules and terms of the agreement before you apply. You should also consider all other options, since there are definite risks to borrowing from your 401(k). Once you’ve decided on the path that’s right for you, be sure to come up with a budget and savings plan to help you avoid needing to borrow in the future.

 

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