How Much Can You Borrow From Your 401
In general, you can borrow the greater of $10,000 or 50% of your vested account balance up to $50,000. You are limited to the balance in your current companys 401, not the collective balance of all of your retirement accounts. You may, however, be able to roll over funds into your current 401 to increase the amount you can borrow. You are limited to borrowing from the assets in your current employers 401 plan.
When You Have A Comfortable Retirement Cushion
If youve been saving steadily over the years and choosing solid investments, you may be ahead of schedule when it comes to meeting your retirement goal. If thats the case, and your job is stable, taking a loan from your 401 may not be too detrimental to your retirement outlook. You could use the money for the purchase of a vacation home, for exampleor, if you have a child in college, as a less expensive alternative to student loans.
Hardship Withdrawal Vs 401 Loan: An Overview
Is it ever OK to borrow from your 401 plan, either as a 401 loan or a hardship withdrawal? After all, your plan is a powerful retirement savings tool and should be carefully handled. Indeed, data from Fidelity shows that the average account balance has climbed to $112,300, as of February 2020.
The recently enacted CARES Act lets you make a penalty-free COVID-19 related withdrawal or take out a loan from your 401 in 2020 with special repayment provisions and tax treatment.
The primary advantage of saving in a 401 is the ability to enjoy tax-deferred growth on your investments. When youre setting aside cash for the long term, a hands-off approach is usually best. Nevertheless, there are some scenarios in which taking money out of your 401 can make sense.
Before you pull the trigger, though, its important to understand the financial implications of tapping your retirement plan early. There are two basic avenues for taking some money out before reaching retirement age.
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What Happens With My 401k Loan When I Leave My Job
If you quit your job with an outstanding 401 loan, the IRS requires you to repay the remaining loan balance within 60 days. Fail to repay within that time, and the IRS and your state will deem the balance as income for that tax year. Youll need to pay income tax and face a 10% penalty tax in addition.
Think About What Would Happen If You Lost Your Job
This is really important. If you lose your job, or change jobs, you cant take your 401 loan with you. In most cases you have to pay back the loan at termination or within sixty days of leaving your job. This is a big consideration. If you need the loan in the first place, how will you have the money to pay it back on short notice? And if you fail to pay back the loan within the specified time period, the outstanding balance will likely be considered a distribution, again subject to income taxes and penalties, as I discussed above. So while you may feel secure in your job right now, youd be wise to at least factor this possibility into your decision to borrow.
Smart Move: To lessen the odds of having to take a 401 loan, try to keep cash available to cover three to six months of essential living expenses in case of an emergency.
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Personal Loan Or 401 Loan: Which Is Right For You
Should you get a personal loan or a 401? Unfortunately, theres no universal answer. It really depends on your situation.
The case for a personal loan is strong if you qualify for the lowest interest rates and can afford the monthly payment. Youd also lean toward a personal loan if your job situation isnt rock solid if youre looking elsewhere or your position is shaky for any reason, a personal loan is much less risky than a 401 loan. It doesnt help to save 15% on interest if you get hit with 40% in penalties for leaving your employer. A personal loan also makes sense if you dont need to borrow more than a few thousand dollars. Thats because the setup and admin costs of a 401 loan could be disproportionately high when you borrow a small amount.
On the other hand, you have a pretty good argument for getting a 401 loan if you feel very secure in your job. Thats even more true if your credit isnt good enough to get an affordable personal loan interest rate. Most 401 plans dont charge you more interest if your credit is bad, and in any case, you pay that interest right back to yourself. Another advantage of 401 loans is that you can make up missed payments without penalty and without harming your credit.
If you take a loan against your 401, and then want or need to leave your job, you may be able to prevent some or all of the tax penalties by paying off the 401 loan with a personal loan. Read on to see how.
Other Alternatives To A 401 Loan
Borrowing from yourself may be a simple option, but its probably not your only option. Here are a few other places to find money.
Use your savings. Your emergency cash or other savings can be crucial right now and why you have emergency savings in the first place. Always try to find the best rate on an online savings account so that youre earning the highest amount on your funds.
Take out a personal loan. Personal loan terms could be easier for you to repay without having to jeopardize your retirement funds. Depending on your lender, you can get your money within a day or so. 401 loans might not be as immediate.
Try a HELOC. A home equity line of credit, or HELOC, is a good option if you own your home and have enough equity to borrow against. You can take out what you need, when you need it, up to the limit youre approved for. As revolving credit, its similar to a credit card and the cash is there when you need it.
Get a home equity loan. This type of loan can usually get you a lower interest rate, but keep in mind that your home is used as collateral. This is an installment loan, not revolving credit like a HELOC, so its good if you know exactly how much you need and what it will be used for. While easier to get, make sure you can pay this loan back or risk going into default on your home.
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Avoid The 401 Early Withdrawal Penalty
While the age for avoiding the penalty is normally 59 1/2, there is an exception to the age rule. If you leave a job or are terminated at age 55 or later, then you can make withdrawals from your account with that employer without paying the penalty. Make sure that you do not make withdrawals from any other plans you might have as those will still be subject to the penalty.
Likewise, remember that there are even heavier penalties for missing required minimum distributions . Upon reaching age 72, you are required to withdraw certain amounts from your account. If you fail to make the withdrawal, then you will receive a penalty of 50% of the amount of the required distribution. Suppose you were required to withdraw $8,000 from your 401. If you miss that distribution, then you will owe $4,000 in the penalty alone!
How Much Does It Cost
Most 401k plans charge a one-time loan origination fee. You will also pay interest along with your loan principal payments. The interest rate on your loan is determined by your 401k plan, but is typically the prime rate + 1%. Check with your employer or review your plans loan policy to make sure you understand any fees that you may need to pay.
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Why Is A 401k A Bad Idea
Theres more than a few reasons that I think 401s are a bad idea, including that you give up control of your money, have extremely limited investment options, cant access your funds until your 59.5 or older, are not paid income distributions on your investments, and dont benefit from them during the most expensive
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Leaving Work With An Unpaid Loan
Suppose you take a plan loan and then lose your job. You will have to repay the loan in full. If you don’t, the full unpaid loan balance will be considered a taxable distribution, and you could also face a 10% federal tax penalty on the unpaid balance if you are under age 59½. While this scenario is an accurate description of tax law, it doesn’t always reflect reality.
At retirement or separation from employment, many people often choose to take part of their 401 money as a taxable distribution, especially if they are cash-strapped. Having an unpaid loan balance has similar tax consequences to making this choice. Most plans do not require plan distributions at retirement or separation from service.
People who want to avoid negative tax consequences can tap other sources to repay their 401 loans before taking a distribution. If they do so, the full plan balance can qualify for a tax-advantaged transfer or rollover. If an unpaid loan balance is included in the participant’s taxable income and the loan is subsequently repaid, the 10% penalty does not apply.
The more serious problem is to take 401 loans while working without having the intent or ability to repay them on schedule. In this case, the unpaid loan balance is treated similarly to a hardship withdrawal, with negative tax consequences and perhaps also an unfavorable impact on plan participation rights.
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Substantially Equal Period Payments
Substantially Equal Period Payments might be a good option if you need to withdraw money for a long term need. These payments must last a minimum of 5 years or until you reach the normal 401k withdrawal age of 59 1/2, whichever is shorter. For this reason, this is not a good option if you have a short term need like a sudden unexpected expense. You cannot withdraw funds under this method if you still work for the employer through which you have the 401. To calculate the amount of these payments, the IRS recognizes three acceptable methods.
Can I Withdraw From My 401k If I Have An Outstanding Loan
Most 401 plans allow participants to tap into their retirement savings. Find out if you can withdraw from your 401k if you have an unpaid 401 loan.
When contributing to a 401 plan, most people have every intention of accumulating a sufficient retirement nest egg that they can live off in retirement. However, when heavy financial emergencies occur and you do not have an emergency fund, you could be forced to raid your retirement savings to settle the urgent financial needs.
Most 401 plans allow you to take a 401 loan against your retirement savings, or a hardship withdrawal if you are below 59 Â½. However, there are circumstances when you can withdraw from your 401 if you have an unpaid loan. For example, if you leave your job or are fired, you could rollover your 401 to an IRA or the new employerâs 401 even if you have an outstanding 401 loan. When this happens, the outstanding 401 balance will not be rolled over, and you will have until the tax due date to pay off the loan balance.
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Repayment Terms On 401 Loans
- You must pay back your loan within five years. You can do so via automatic payroll deductions, the same way you fund your 401 in the first place. There is no penalty for paying off the loan sooner than that.
- You must pay interest on the loan, at a rate specified by your 401 fund administrator. Typically the rate is calculated by adding one or two percentage points to the current prime interest rate.
Bad Reasons To Borrow Against A 401k
If youre borrowing money for ordinary expenses that should be part of your budget like mortgage or rent payments you have a spending problem. These are not unexpected expenses they are what it costs to live your life. You either need to spend less money or make more, ideally both.
Your 401k is also not an emergency fund. You should have at least $1000 in an emergency fund and ultimately six months worth of expenses. That is the money you use for an unexpected expense like a significant car or home repair.
Your 401k is not a source of discretionary spending. Do not pay for things like a vacation or a house full of new furniture. Those are things you have to save up for. Your 401k isnt savings its retirementsavings.
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At What Age Is 401k Withdrawal Tax Free
The 401 Withdrawal Rules for People Older Than 59 ½ Stashing pre-tax cash in your 401 also allows it to grow tax-free until you take it out. Theres no limit for the number of withdrawals you can make. After you become 59 ½ years old, you can take your money out without needing to pay an early withdrawal penalty.
Can I Borrow From My 401k If I No Longer Work For The Company
401k Plan Loans An Overview. There are opportunity costs. If you quit working or change employers, the loan must be paid back. If you can t repay the loan, it is considered defaulted, and you will be taxed on the outstanding balance, including an early withdrawal penalty if you are not at least age 59 ½.
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Fully Legal And Irs Compliant
In 1974, Congress enacted the Employee Retirement Income Security Act to shift the burden of building retirement assets from the employer to the employee. ERISA, when paired with specific sections of the Internal Revenue Code, makes it legal to tap into your eligible retirement accounts without an early withdrawal fee or a tax penalty.
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Under What Circumstances Can A Loan Be Taken From A Qualified Plan
A qualified plan may, but is not required to provide for loans. If a plan provides for loans, the plan may limit the amount that can be taken as a loan. The maximum amount that the plan can permit as a loan is the greater of $10,000 or 50% of your vested account balance, or $50,000, whichever is less.
For example, if a participant has an account balance of $40,000, the maximum amount that he or she can borrow from the account is $20,000.
A participant may have more than one outstanding loan from the plan at a time. However, any new loan, when added to the outstanding balance of all of the participants loans from the plan, cannot be more than the plan maximum amount. In determining the plan maximum amount in that case, the $50,000 is reduced by the difference between the highest outstanding balance of all of the participants loans during the 12-month period ending on the day before the new loan and the outstanding balance of the participants loans from the plan on the date of the new loan.
A plan may require the spouse of a married participant to consent to a plan loan. )
A plan that provides for loans must specify the procedures for applying for a loan and the repayment terms for the loan. Repayment of the loan must occur within 5 years, and payments must be made in substantially equal payments that include principal and interest and that are paid at least quarterly. Loan repayments are not plan contributions. -1, Q& A-3)
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Alternatives To Borrowing From Your 401
Some 401 plans allow hardship withdrawals for circumstances like preventing eviction from your apartment or making needed repairs to your home. If you take a hardship withdrawal, you will pay federal and possibly state income taxes on the amount you withdraw, as well as a 10% federal tax penalty if you are not yet age 59 1/2.
You might also consider borrowing money from a bank or a relative. And if you owe a lot of money, you could consult with a to find ways to help you get out of debt. As a last resort, you might decide to hire a bankruptcy attorney to wipe out your debt while preserving your 401 and other retirement money.
Pros And Cons Of Borrowing A 401 Loan
|You might get a lower interest rate than you would on a different type of loan
|The amount you borrow will no longer be invested, so you could miss out on interest earnings
|You dont have to pass a credit check to borrow
|Youll pay back the loan with after-tax income and might get taxed on it again when you make withdrawals during retirement
|You have up to 5 years to pay back the loan
|You might rack up fees and penalties if you dont pay your loan back on time
|You can access the money relatively quickly
|If you change or lose your job, you might have to pay it back right away
While a 401 loan can make sense in some circumstances, it also has some inherent risks. Consider all the pros and cons before borrowing so you can make an informed decision and not inadvertently threaten your retirement savings.
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