How to Do a 401(k) Loan

Many 401(k) plans allow you to borrow money from your self-funded retirement plan with a 401(k) loan. This is a step that should be taken with caution, since funds you borrow from your retirement investments will not earn money for your retirement. Still, it may be a better way to borrow money to meet a short-term need than taking a cash advance on a credit card or using a payday loan. The funds can be used for a limited set of purposes, including, in most cases, to purchase a home or pay for health care expenses. You can borrow money from your 401(k) free of penalties and tax consequences, but you must be careful to remain within the allowable criteria for spending the money so that the IRS doesn't consider it an early retirement withdrawal, which would cost you a 10 percent penalty plus income taxes in the year in which you withdraw the money. Each plan has slightly different 401k loan rules, but here is the basic process.

Step 1

Talk to your 401(k) retirement plan administrator. Your first contact should be your human resources or payroll department. They either handle the 401(k) program or can refer you to an external person who handles 401(k) loans, 401(k) withdrawals, and other 401(k) questions.

Step 2

Ask about the rules for borrowing from your retirement plan. Most plans will allow you to borrow up to a certain percentage (usually 50 percent or less) of your 401(k) account balance. Make sure to ask about the loan repayment rules.

Step 3

You will usually be required to make minimum monthly payments, plus interest. The interest usually goes into your account. But keep in mind that while you are "making" loan interest, you are missing out on the opportunity for that portion of your money to grow in mutual funds. Also, you are footing the bill for that investment "growth".

Step 4

Make sure to ask about the rules when you leave the company. With most plans, you will be required to pay back the entire balance of the loan when you leave the company, usually within 90 days of termination. If you don't, the IRS may require stiff penalties when you file your taxes at the end of the year.

Tip

If you have to borrow from your 401(k) retirement plan, pay it back as soon as possible. Pay very close attention to the rules from your 401(k) administrator. See if your plan allows you to borrow money online. Only borrow against your 401(k) if you have a specific repayment plan. This will be critical to your debt management plan. A 401(k) loan can be a good way to access a large amount of cash, but beware of the consequences. It can be used to pay down debt or pay for an emergency.

Warning

You should only borrow from your 401(k) if you are in a very desperate situation, such as a family medical emergency. It is usually unwise to use 401(k) assets to pay down debt. Work with your tax advisor to understand the implications of borrowing against your retirement account. Be especially cautious about borrowing money from your 401(k) right before retirement. Pay down your 401(k) loan debt as quickly as possible.

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