401k Loan – How to borrow from your 401(K)?

If your plan document allows you to borrow for a specific reason then you can qualify for a 401k loan. Most 401(k) plans allow borrowing money only for certain specified reasons.

And yes, watch out before you start borrowing money. Check out the 5-Must Known Facts about taking a 401k loan.

5-MUST KNOW FACTS about the 401k Loans:

  1. If you are taking a 401k loan, your ability to get a general mortgage may be affected. With the 401k loan, you are also incurring debt. And yes, that debt needs to be paid by revolving monthly payments.
  2. Check the interest rate. Compared to the prime rate it’s usually two points above. However, the interest payment goes into your 401k account and isn’t paid to the company.
  3. Short-Term repayment plans. Watch out. A typical 401k plan is not set up for 30 years. In general, a 401k plan gives you five years to repay the loan. If you are going to consider taking a 50k loan, make sure you are able to make substantial monthly payments. 
  4. You quit your job, or like uncle Trump used to say: You are fired! What happens next? Well, in that case, you may be required to pay back the outstanding balance within 60 to 90 days or be forced to take it as a hardship withdrawal. Therefore, you’ll be hit with penalties on the amount you still owe plus taxes. Ouch. This really hurts! 
  5. Another disadvantage almost no one considers. Your interest payments will end up being double-taxed. Kaboom. The principal payments will not be taxed. However, the interest payments will. 

How much money do you need to have in your 401k to get a loan?

If you have a vested balance of at least $100.000 or 50% of the value, you can borrow up to $50,000. After you have identified what account qualifies and you want to borrow money from you let the 401k company know.  Those 401k investments will be liquidated. If those investments might have made any gains during the duration of the loan – you will lose them. 

Disadvantages when you borrow against your 401k?

If you are borrowing from your 401k you’ll lose out on tax efficiency. Savers’ 401k money is taxed again when withdrawn in retirement, so those who take out a loan are subjecting themselves to double taxation.

Attention: a lot of 401k plans have rules that can become an instant problem if you leave your job if you are laid off or fired. In this case, it’s very typically to repay your loan within 60 days. Watch out for that!

Can you still contribute to 401k with loan?

While you are repaying your 401(k) loan, you may or may not be allowed to make your normal pretax contributions, depending on your employer’s plan rules. If your employer will not allow you to make new contributions while you have a loan outstanding, you lose the opportunity to increase your 401(k) balance.

Is it smart to borrow from 401k to buy a house?

5-Step Checklist to borrow from your 401(k)

So far I highlighted the most important facts. As you can see: Taking a 401k Loan is not really the best option, because of the hidden traps I called out. In case you still want to move forward, here are 5-Easy Steps how to borrow money from your 401k.

  1. If you have particular account loans, then get all the details. The best is if you talk to your 401(k) plan provider. Call your benefits office and check out your summary plan description.
  2. Let’s figure out how much money you can borrow. There are limits set by the government on how much you can borrow. Usually, 50% of your account value is allowed to borrow up to $50,000 maximum. The government made a bunch of other rules which theoretically gives you permission to borrow 100 percent of an account up to $10,000. However. the majority of the plans don’t allow this; in fact, all loans are limited to 50 percent of the account value. 
  3. Check your interest rate. The interest rate is one of the most important factors to consider. If you are going for a 401(k) loan your employer determines the rate. However, it must be a level that meets IRS requirements. It’s important to double-check the rates – a general percentage can’t be applied.
  4. Check the repayment period. Every loan is usually bound to a deadline. And so it is with the 401k loan. In general, within 5-years the 401k loan has to be repaid. And of course, if your plan permits, you can repay it faster. In case you use the money for a house purchase, your employer may permit a longer repayment period. 
  5. Check the methods for repayment. In most cases, the loan is going to be repaid through deductions from your paycheck. One important fact to know: The repayments for your 401k loan are taken out of your paycheck after taxes. 

What happens if you don t pay back a 401k loan?.

If you can’t repay the loan, it is considered defaulted. Then, you’ll be taxed on the outstanding balance, including an early withdrawal penalty if you are not at least age 59 ½. Interest on the loan is not tax-deductible, even if you borrow to purchase your primary home.

How long does it take to get money from 401k?

It typically takes around one to two weeks to get cash from your 401(k). Sometimes it can take considerably longer – depending on the 401k companies. The countdown starts when you request your payout and ends when you actually receive the cash, either as a check or a bank deposit.

Do you have to claim a 401k loan on your taxes?

A 401k loan is Not Taxable Income. A loan from your 401(k) will not be treated as taxable income and is not to be reported on your income taxes. You made the original contributions to your 401(k) with pre-tax dollars, and the tax on those contributions is deferred until you begin taking withdrawals after age 59 1/2.

Does a 401k loan hurt your credit?

Borrowing from the 401k does not affect your credit (FICO) score. I recommend you check with your plan provider about the terms and conditions of borrowing from a 401k. As a general rule, it is not recommended to borrow from 401k, because of potential taxes, loss of income at retirement.

Do 401k loans show on credit report?

Will a 401k loan appear on my credit report? Answer: No. Loans from your 401k are not reported to the credit-reporting agencies, but if you are applying for a mortgage, lenders will ask you if you have such loans and they will count the loan as debt.

You can read more about 401k loans, directly at the IRS Website.