7 Need-to-Know Things About 401(k) Loans | The Motley Fool (2024)

FAQs

7 Need-to-Know Things About 401(k) Loans | The Motley Fool? ›

The maximum amount that the plan can permit as a loan is (1) the greater of $10,000 or 50% of your vested account balance, or (2) $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.

The maximum amount that the plan can permit as a loan is (1) the greater of $10,000 or 50% of your vested account balance, or (2) $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.

The ability to take out a loan helps make a 401(k) plan one of the best retirement plans, but a loan has some key disadvantages. While you'll pay yourself back, you're still removing money from your retirement account that is growing tax-free. And the less money in your plan, the less money that grows over time.

The maximum amount a participant may borrow from his or her plan is 50% of his or her vested account balance or $50,000, whichever is less. An exception to this limit is if 50% of the vested account balance is less than $10,000: in such case, the participant may borrow up to $10,000.

If your 401(k) plan allows loans, you can generally take a loan when the following conditions are met: The amount of the loan cannot exceed the lesser of: $50,000, minus your highest outstanding loan balance during the past 12 months, or. The greater of $10,000 or ½ of your vested account balance.

For example, some 401(k) plans may allow a hardship distribution to pay for your, your spouse's, your dependents' or your primary plan beneficiary's: medical expenses, funeral expenses, or. tuition and related educational expenses.

One of the easiest ways to lower the amount of taxes you have to pay on 401(k) withdrawals is to convert to a Roth IRA or Roth 401(k). Withdrawals from Roth accounts are not taxed. Some methods allow you to save on taxes but also require you to take out more from your 401(k) than you actually need.

Before borrowing, consider that you'll have to repay the loan with after-tax dollars, and you could lose investment earnings on the money while it's out of the account. Should you lose your job, you'll have to repay the loan more rapidly, or face the possibility that it will be treated as a distribution.

The IRS allows penalty-free withdrawals from retirement accounts after age 59½ and requires withdrawals after age 72. (These are called required minimum distributions, or RMDs). There are some exceptions to these rules for 401(k) plans and other qualified plans.

Can you be denied for a 401K loan? ›

Although your credit doesn't affect your ability to get a 401(k) loan, your plan administrator could deny your loan request for other reasons. For example, it might not approve you for a loan if you have an outstanding 401(k) loan.

Any money borrowed from a 401(k) account is tax-exempt, as long as you pay back the loan on time. And you're paying the interest to yourself, not to a bank. You do not have to claim a 401(k) loan on your tax return.

In most cases, it would be better to leave your retirement savings fully invested and find another source of cash. On the flip side of what's been discussed so far, borrowing from your 401(k) might be beneficial long-term—and could even help your overall finances.

Most employer 401(k) plans will only allow one loan at a time, and you must repay that loan before you can take out another one.

You pay the interest to yourself, but…

Here's why. To pay interest on a plan loan, you first need to earn money and pay income tax on those earnings. With what's left over after taxes, you pay the interest on your loan. That interest is treated as taxable earnings in your 401(k) plan account.

When will the loan be due? The “termination date” will either be your last day of employment with the company or the date your employer set as the last day the plan is active. You must pay off the loan in full no later than 90 days from the termination date.

More In Retirement Plans

Individuals who are age 50 or over at the end of the calendar year can make annual catch-up contributions. Annual catch-up contributions up to $7,500 in 2023 and 2024 ($6,500 in 2021-2020; $6,000 in 2015 - 2019) may be permitted by these plans: 401(k) (other than a SIMPLE 401(k)) 403(b)

In general, a 401(k) loan must be paid back within five years, unless the funds are used to purchase a home. In that case, you have longer. 2 You can also pay back the loan sooner without being subject to prepayment penalties. Like 401(k) contributions, loan repayments are typically made through payroll deductions.

Under the rule of 55, the IRS permits you to withdraw money from your current 401(k) or 403(b) plan before age 59½ without paying a 10% penalty on the amount withdrawn if both of the following are true: (1) Withdrawals occur in the year you turn 55 or later, and (2) you have left your employer.

Important reminder: The 50/30/20 budget rule only considers your take-home pay for the month, so anything automatically deducted from your paycheck — like your work health insurance premium or 401k retirement contribution — doesn't count in the equation.