Most individuals have the option to make a hardship withdrawal or take a loan from their retirement plans. Owners of retirement plans such as a 401(k) typically incur a 10 percent penalty fee and taxes when they withdraw money before the set retirement age. However, the Internal Revenue Service makes exceptions for loans. Proceeds from loans are not subject to taxes or typical penalty fees. Still, borrowers almost always have to pay interest on loans and it can be difficult to rebuild the account balance.
Hardship Withdrawals Versus Loans
Retirement plan loans are much more flexible than hardship withdrawals. There are only a handful of acceptable reasons for a hardship withdrawal. You may take a withdrawal for un-reimbursed medical expenses for you or your family. Purchase of your principal residence, to prevent foreclosure or to repair your home are acceptable reasons. You can also use the proceeds for educational and funeral expenses. On the other hand, there is no restriction on how borrowers spend the proceeds from a retirement plan loan.
Pick a Number
Determine the amount of your loan. Loans from a retirement plan are generally limited to the lower of $50,000 or 50 percent of your account balance. When choosing a number, consider how the amount will affect your future account balance. You can't contribute to the retirement plan for six months after taking out a loan, which makes it harder to build back up the balance in your retirement account.
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Request the Loan
Apply for a loan through your retirement plan administrator. Although the government allows retirement plan administrators to make loans available, employers have the power to prohibit the loans. If loans are available, fill out the 401(K) loan request form available through your plan administrator. You'll need to provide applicable information like your retirement account number, Social Security number, how much money you want to withdraw and how you want to receive the proceeds.
Pay it Back
Create a plan to repay the loan. Payments are generally made through payroll deductions. Borrowers must pay back the balance of the loan, with interest, over the course of five years unless the withdrawal is for the purchase of a home. The good news is that the payments and the interest increase your plan balance. However, borrowers still lose the compound interest they would have earned on the retirement funds they took as a loan. To mitigate this effect, consider increasing your contribution amount or make a catch-up contribution.