Some 401k plans provide loan options that allow workers to borrow against the funds in their retirement account. The law allows you to borrow up to 50 percent of the 401k value or $50,000, whichever amount is less, according to Consumer Credit Counseling Services. Unlike early 401k withdrawals, 401k loan borrowers don't face tax penalties. However, before borrowing from a 401k plan, you'll need to learn if your plan administrator offers this program. You'll also need to become familiar with the borrowing rules and restrictions.
Ask if the plan administrator offers 401k plan loans. Most administrators offer this loan option; companies aren't required to offer it, however. If the company offers this loan program, request a loan application. Complete the application and return it to the plan administrator.
Choose a loan term. Borrowers have up to five years to pay back a 401k loan. A shorter term will have higher monthly payments. However, it will minimize the total interest paid on the loan. Choose the shortest loan term you can afford.
Ask about the interest rate on the loan. Typically, 401k plans offer low interest rates because the loan is secured by an asset. Interest rates often are set at prime rate (published in The Wall Street Journal) plus 1 percent.
Set up a payroll deduction. Most lenders require a payroll deduction for 401k loan payments. This will require providing bank account information for the lender to make the withdrawals. Withdrawals are typically made with each pay period. For example, if the monthly payment is $500 and you get paid twice monthly, $250 will be taken from each pay period.
When you make an early withdrawal from a 401k plan, you are liable for taxes plus a 10 percent penalty. However, borrowing from a 401k plan doesn’t have this penalty. As long as the loan is repaid on time, no penalty is required. If the loan isn’t repaid on time, however, you will be subject to penalties.
If you borrow for the purchase of a home, you have longer than five years to repay the loan, according to Consumer Credit Counseling Services. Plan administrators allow 10 to 30 years to repay these loans, although the actual term varies by plan.
Don’t forget to weigh the cons of taking out a loan against 401k savings. For example, if you borrow $50,000 you are losing out on investment returns on the $50,000 over the term of the loan. This can significantly deplete your retirement savings.