What Are the 401(k) Loan Limits?
Your 401(k) is subject to legal loan limits set by law. The maximum amount you can borrow is traditionally the lesser of $50,000 or 50% of your vested account balance, whichever is less. Your vested account balance is the amount that belongs to you. If your company matches some of your contributions, you may have to stay with your employer for a set amount of time before the employer contributions belong to you. Your 401(k) plan may also require a minimum loan amount.
Repaying the 401(k) Loan
You should make payments at least quarterly, but commonly, this interval is manageable as you’ll repay your loan through payroll deductions. The longest repayment term allowed is five years, although there are exceptions. Some 401(k) plans do not allow you to contribute to the plan for a certain period after you take out a loan. If you lose your job while you have an outstanding 401(k) loan, you may need to repay the balance in full or risk having it be categorized as an early distribution, which can result in both taxes owed and a penalty from the IRS.
Interest Payments
You will pay yourself interest. The interest rate on your 401(k) loan is determined by the rules in your 401(k) plan, but it is typically set up as a formula (for example, the prime rate plus 1%). Although you pay the interest back to yourself, taking a 401(k) loan tends to hurt your future retirement savings .
Caveats to Borrowing From Your 401(k)
Some 401(k) plans allow a withdrawal in the form of a loan, but some do not. You must check with your 401(k) plan administrator or investment company to find out whether your plan allows you to borrow against your account balance. You can usually find their contact information on your statement.
Borrowing from an Old 401(k)
If you are no longer working for the company where your 401(k) plan resides, you may not take out a new 401(k) loan unless your plan specifically allows for it. You may transfer the balance from a former employer to your new 401(k) plan, and if your current employer plan allows for loans, then you can borrow from there. If you transfer your old 401(k) to an IRA, you cannot borrow from the IRA. It is best to know all the rules before you cash out or transfer an old 401(k) plan.
Using Your 401(k) Loan Wisely
These loans are frequently used to pay debts or home repairs or improvements. Other major uses include buying or refinancing homes, buying automobiles, and paying for college tuition, medical costs, and vacation or wedding expenses.
Late Repayment Is Potentially Costly
When you take a 401(k) loan, you pay no taxes on the amount received. However, if you don’t repay the loan on time, taxes and penalties may be due. Specifically, if the loan is not repaid according to the specific repayment terms, then any remaining outstanding loan balance can be considered a distribution. In that case, it becomes taxable income to you, and if you are not yet 59 1/2 years old, a 10% early-withdrawal penalty tax will also apply.
