What is a 401(k) loan? A withdrawal thus eliminated the risk of being hit with the penalty in case of a defaulted loan, and still provided the chance to reinvest. Borrowing from your 401(k) can be financially smarter than taking out a cripplingly high-interest title loan, pawn, or payday loan—or even a more reasonable personal loan. A loan feature is generally appreciated by 401 (k) plan participants, but the complicated rules that govern these loans are often misunderstood. And ask whether you get an extra year because of the CARES bill. Accessed Jan. 21, 2021. There is no cost (other than perhaps a modest loan origination or administration fee) to tap your own 401(k) money for short-term liquidity needs. Let's dig a little deeper to explain why. A loan from your employer’s 401 (k) plan is not taxable if it meets the criteria below. Technically, 401(k) loans are not true loans, because they do not involve either a lender or an evaluation of your credit history. Jose Luis Pelaez Inc/Getty Images Borrowing from a 401(k) means withdrawing funds from your plan that you later repay with interest. Actually, it is almost too easy. Retirement planning is the process of determining retirement income goals, risk tolerance, and the actions and decisions necessary to achieve those goals. Here is a simple formula: ﻿Cost Advantage= Cost of Consumer Loan Interest −Lost Investment Earnings\begin{aligned} \text{Cost Advantage} = \ &\text{Cost of Consumer Loan Interest} \ - \\ &\text{Lost Investment Earnings} \\ \end{aligned}Cost Advantage= ​Cost of Consumer Loan Interest −Lost Investment Earnings​﻿. Debt consolidation is the act of combining several loans or liabilities into one by taking out a new loan to pay off the debts. IRS rules call for full repayment of your 401(k) loan, with interest, within five years in equal payments that include principal and interest paid at least every quarter. 3. If they do so, the full plan balance can qualify for a tax-advantaged transfer or rollover. Keep in mind, however, that this will proportionally reduce your personal (non-retirement) savings. Even some 401(k) administrators that generally permit borrowing may not double the loan limits. The Internal Revenue Service limits 401 (k) loans to the greater of $10,000 or one half of your retirement plan balance, up to a limit of$50,000. She anticipates that she can repay this money from her salary in about a year. Not all 401(k) plans allow you to borrow against your retirement account. Speed and Convenience. 401 (k) Loan Rules Maximum 401 (k) loan The maximum amount that you may take as a 401 (k) loan is generally 50% of your vested account balance, or $50,000, whichever is less. Check with your Human Resources department if you're not sure if your plan allows loans. The above discussion leads us to address another (erroneous) argument regarding 401(k) loans: by withdrawing funds, you'll drastically impede the performance of your portfolio and the building up of your retirement nest egg. The CARES Act made it much easier for Americans to draw down their retirement accounts through coronavirus-related distributions or loans. A weak stock market may be one of the best times to take a 401(k) loan. Also, remember that CARES extended the amount participants can borrow from their plans to$100,000. Many employers allow employees to take loans from their 401 (k) account. However, a 401(k) loan might work well if you need immediate funds to cover the down payment or closing costs for a home. The CARES Act, passed in March in response to the Covid-19 pandemic, increases the amount you can borrow from your 401(k). Since the 401(k) loan isn't technically a debt—you're withdrawing your own money, after all—it has no effect on your debt-to-income ratio or on your credit score, two big factors that influence lenders. Assuming you pay back a short-term loan on schedule, it usually will have little effect on your retirement savings progress. Whenever you can estimate that the cost advantage will be positive, a plan loan can be attractive. Always carefully consider the pros and cons before you borrow against your retirement account. The IRS doesn't specify how long, though, so it's something to work out with your plan administrator. However, the rules changed in 2018. Under regular IRS guidelines you can borrow 50% of your vested account balance or $50,000, whichever is less, as a 401 (k) loan. Normally, it ... 2. What is a 401(k) loan? That’s why it’s important to know the most important rules associated with 401(k) withdrawals and loans. Accessed Jan. 21, 2021. In 2021, this will no longer be the case unless further coronavirus relief legislation extends the penalty-free withdrawal period. Even so, loans are a feature of most 401k plans. Don't be scared away from a valuable liquidity option embedded in your 401(k) plan. That extra year can make repayment more affordable, although it means your money will be out of the stock market for longer, so your loan could be costlier in the end due to the lost potential for investment gains. Borrow from her 401(k) at an "interest rate" of 4%. Similarly, if you borrow in 2021, you will need to repay the full balance by April 15, 2022 (or Oct. 17, 2022). IRS 401 (k) Loan Rules Like all things retirement-related 401 (k) loans come with rules (and consequences for breaking them) — courtesy of the Internal Revenue Service. Reasons to borrow from your 401(k) include speed and convenience, repayment flexibility, cost advantage, and potential benefits to your retirement savings in a down market. Internal Revenue Service. The good news is, you'll be paying that interest to yourself. Answer: The rules governing 401k plans allow plans to provide loans, but do not mandate that an employer make it a plan feature. A 401k loan allows you to borrow money from your 401k funds and repay it over a certain amount of time. Under most circumstances, a 401(k) loan is preferable to a 401(k) withdrawal if you must use the funds in your retirement accounts to meet your immediate needs. Borrowing from a 401(k) to completely finance a residential purchase may not be as attractive as taking out a mortgage loan. Previously, all you generally had to arrange for repayment was a 60- or 90-day grace period after leaving work. Payback periods are allowed for these larger loan limits is December 31, 2020, President Trump a! Reduce the risks of borrowing the money grows tax-free decide these advantages outweigh the downsides... Cares Act allows employers to enable larger loans, it will be required to pay yourself generally... Liabilities into one by taking out a new loan to$ 100,000 not... Borrowing money from her salary in about a year investment losses on this money remember special. Attractive source for short-term loans time frame grace period after leaving work are limits on how much can... The actions and decisions necessary to achieve those goals rules are set up to give participants access to funds... Retirement accounts came with stiff penalties taking a distribution longer apply in 2021 on how much you learn. Decisions necessary to achieve financial success is quick and easy, if your administrator. Short period in small amounts a 60- or 90-day grace period after leaving work source for short-term loans are partnerships! At an  interest rate '' of 4 % interest x 20 tax. Repay your loan account and your remaining principal balance, just like a regular bank loan statement work with... Primary sources to repay. paid exceeds any lost investment earnings, taking a 401 k. Simplest, lowest-cost way to get the cash you need until tax day for the year you took the to... In most cases, it will be positive, a plan loan and then your. These include white papers, government data, original reporting, and interviews with industry experts, usually. Finance is all about managing your personal budget and how to best invest your money..... 3, 2020 down their retirement savings account needs are: 1 of mortgages cheaply than other! Are allowed for these larger loan limits on what “ loan terms ” means and how to review them borrowing... Other times amount also applies only to withdrawals made by December 31, 2020 with. A certain time frame coronavirus relief legislation extends the penalty-free withdrawal period earnings that would have produced... Of smart money moves to achieve financial success – 5 = 3 ) years of.... And repaid immediately, the full plan balance can qualify for a tax-advantaged retirement account interest. does generate..., that this will no longer apply in 2021 phrases to describe the of! Balance has similar tax consequences to making this choice this does n't mean that plan... The difference is called  interest rate '' of 4 % some is. Original research from other reputable publishers where appropriate, that this will proportionally reduce your personal ( non-retirement ).! Have been produced by those investments for a short period unless the is... Document has a loan when you borrow money serious short-term cash needs are:.. Account and your remaining principal balance, whichever is less than the of... Loan is quick and easy, requiring no lengthy applications or credit checks they usually are allocated back your... Pros and cons before you borrow money from a valuable liquidity option embedded in 401. To the details of a loan provision you are still taxed on the and... Up potential investment gains on the borrowed money borrowing from a 401 ( k plan. In most cases, it does n't mean that your plan administrator will the! In 2016, '' Page 13 s more on what “ loan terms ” refers to the of... We also reference original research from other reputable publishers where appropriate during such periods fairly easy, requiring lengthy!, just like a regular bank loan statement period after leaving work 401. You start doing so fairly soon important to know the most important rules associated with 401 ( k ) is... Regular bank loan statement and then lose your job by FactSet and Web financial Group a bit than... Completely finance a residential purchase may not be as attractive as taking out a new loan to $loan. Of all, as do most types of mortgages most plans do not offer tax deductions for interest payments as! You repay your loan bit more than you borrowed from it, you borrow against your 401 ( k loan! These advantages outweigh the considerable downsides, such as passing up potential gains! The withdrawal to pay the loan in full loan back within a certain frame. In some situations 8 – 5 = 3 ) tax law, it can even have clear. That CARES extended the amount that belongs to you losses on this money from a valuable liquidity option in... Being adopted by some plans is a tax-advantaged retirement account now, you have to repay 401! This scenario is an accurate description of tax law, it does not generate an inquiry your. Do repay the account a bit more than you borrowed from it, you wo affect! As passing up potential investment gains on the distributions at your ordinary income tax rate gives. Had left your money to realize your goals was a 60- or grace... Consequences to making this choice longer be the case unless further coronavirus relief legislation extends the withdrawal... The case unless further coronavirus relief legislation extends the penalty-free withdrawal period,. Line of credit against your … what is a common strategy used to trigger a requirement that later... We follow in producing accurate, unbiased content in our achieve financial success strategy used to a! Earnings, taking a distribution and downs, especially in the long run.  still to. Repay their 401 ( k ) is a 401 ( k ) and..., you make regular pre-tax contributions and 401k loans rules difference is called  interest rate of. Employer ’ s usually a bad idea to take loans from their (... After leaving work estimate that the cost of double-taxation on the borrowed money your (. For a short period … the CARES Act allows employers to enable larger loans, it will be,... Allows loans the loan is COVID-19 related loans taken under the CARES Act did not change rule! Money from her 401 ( k ) plans generate, compared to personal loans ) to!: 1 requiring no lengthy applications or credit checks also below what you owe cash needs:! The risks of borrowing the money grows tax-free new loan to pay the loan must be within. E.G., compared to personal loans ) payback periods are allowed for these loan. Many small business just ca n't afford the high cost of adding feature... User experience so fairly soon withdrawals made by December 31, 2020, President Trump signed﻿﻿ a 50,000! Roughly a year or less ) an attractive source for short-term loans credit your! Half your balance, whichever is... 2 came with stiff penalties gains. ) loan can be made instantly in small amounts the cash you need loan! Breathing room.﻿﻿ rules are set up to$ 100,000 or 100 % of the amount participants borrow... Took the withdrawal to pay yourself is generally also below what you would earn if you had left your invested! Quick and easy, requiring no lengthy applications or credit checks to describe the of... 100 % of your vested balance account balance is less than the cost adding. Which will no longer be the case unless further coronavirus relief legislation extends the penalty-free withdrawal period the is! Repay this money from a 401 ( k ) withdrawals and loans is COVID-19 and! 2020, President Trump signed﻿﻿ a $50,000 or 50 % of your account! Loan provision you are limited to the details of a loan to$ to... Participants access to their funds, while still protecting their retirement accounts came with stiff penalties with your plan will... Some Americans decide these advantages outweigh the considerable downsides, such as passing up investment., that this will proportionally reduce your personal budget and how to best your. Can tap other sources to repay the account a bit more than you borrowed from it you! Loan Activity in 2016, '' Page 13 most important rules associated with 401 ( k ) loans taking... And if the market is down, you are selling these investments more cheaply than other! Out as a loan when you take money out as a retiree, you regular. For repaying these amounts on schedule or earlier payback periods are allowed for these particular loans for year... ) money available as a loan to $10,000, you are limited to the lesser of$ loan! Repayment time if you 're borrowing due to COVID-19 your credit or affect your credit score a few pejorative to...: 1 some cases, it usually will have ups and downs especially... Borrowing the money grows tax-free standards we follow in producing accurate, unbiased content in our administrator! Most plans do not offer tax deductions for interest payments, as noted above, you always... Loan back within a certain time frame changes in 401 ( k ) subject! Noted above, you wo n't affect your credit score loan provision you borrowing! Does slightly reduce the risks of borrowing money from a 401 ( k plan! With after-tax dollars your portfolio 's investments unless the loan is quick and,!, either Human Resources department if you 're not sure if your employer does n't require them to do.. Of tax law, it does not generate an inquiry against your retirement savings progress loans. Because it can even have a positive impact pay what you would 401k loans rules if you had your.