If you contribute to a 401(k) retirement account, you may be able to take a loan from the plan. The maximum amount you can borrow is limited to the lower of $50,000 or up to 50% of your vested account balance. However, some plans may impose lower limits or not offer loans at all. In addition to these restrictions, borrowing from your 401(k) calls for taking into account some significant additional limitations and considerations. A financial advisor can help you save for retirement.
401(k) Loan Basics
You can access funds in your 401(k) by withdrawing money or, in many cases, by taking out a 401(k) loan. If you withdraw money early, before reaching age 59.5, you may have to pay a 10% penalty as well as owe any taxes due. Borrowing against the balance in your plan lets you tap that money at a younger age without having to pay these costs, which makes a loan look more attractive. In order to avoid penalties, however, you’ll have to pay back the loan, including interest.
While IRS rules and federal law allow 401(k) loans, plans are not required to offer them. Some don’t, while others but only with additional restrictions. In all cases, if you borrow the money you have to pay it back, with interest, like a regular installment loan. If you don’t pay on time, your loan may be treated as a withdrawal, activating the penalties and taxes that would be due on a withdrawal.
How Much You Can Borrow
Government rules allow for loans of up to $50,000 or 50% of the vested assets in your account. The lower of these two amounts set the limit. So, for example, if you have $75,000 in fully vested funds in your 401(k), your maximum loan amount would be 50% of that or $37,500.
If 50% of the vested assets in your account come to less than $10,000, you can borrow up to $10,000. Individual plans may have lower limits, however, and some don’t allow loans at all. The only way to be sure you can borrow or how much you can borrow, is to review your plan’s terms.
Multiple 401(k) Loan Limits
You can take out more than one loan at a time from your 401(k). However, that won’t let you get around these limits. If you add up the total balance of all your 401(k) loans, they must not exceed the plan limit. Time is also a factor. According to IRS rules, to calculate the effective cap on what you can borrow if you already have one loan, determine the highest outstanding balance of all your 401(k) loans during the previous 12 months.
Next, determine the outstanding loan balance on the day the proposed new loan would be taken out. Subtract the current outstanding balance from the average of the previous year. Now subtract this figure from the absolute maximum loan amount. This figure represents the largest allowable total loan balance, including previous loans as well as the new loan.
For example, say you can borrow up to $50,000 from your plan and one year previously took out a $40,000 loan that you have since paid down to $32,500. The difference between these amounts is $7,500. Subtracting $75,000 from $50,000 gives $42,500. That is the maximum allowed amount for all loan balances at this time. Since you already owe $32,500, you can borrow up to another $10,000, which will put your total outstanding loan balance at $42,500.
Practical 401(k) Loan Limits
The fact that you can take out a loan of up to $50,000 from your 401(k) doesn’t mean that you should. This financing technique comes with some potential minuses that require careful consideration. Opportunity cost is one. When you borrow from your 401(k), the money you borrow is temporarily removed from your investment portfolio. This means you miss out on potential market gains. The more you borrow, the more you could miss.
Failure to repay a 401(k) loan is another. If you don’t make all your payments within the loan’s time frame, usually five years, the outstanding balance will be treated as a taxable distribution. You’ll owe on it then plus, if you’re under age 59.5, a 10% early withdrawal penalty. Borrowing more than you can really pay back could be a costly error.
If you lose or change your job, whether voluntarily or involuntarily, the outstanding loan balance becomes due, typically within 60 days. If you don’t pay, again it will be treated as an early withdrawal and subject to penalties and taxes. If your employment situation is uncertain, a 401(k) loan may not be the best idea.
Finally, if you have taken out a loan, depending on the plan you may not be able to contribute to your account until you have paid it all back. This could cause you to lose out on employer matches as well as the benefits of current income tax deductions. If it takes longer to pay back a bigger loan, you could miss out on more valuable matches.
The Bottom Line
Borrowing from your 401(k) can provide a convenient and cost-effective source of funds in some situations. Legal, regulatory and specific plan rules limit the maximum amount you can borrow, with either $50,000 or 50% of your vested account assets as the absolute cap. Some plans impose lower limits. Other considerations including opportunity costs and repayment challenges may suggest borrowing less than the rules allow.
Tips for Retirement Planning
- Before making a decision about borrowing from your 401(k), consider consulting with a financial advisor who can help you assess whether a 401(k) loan aligns with your long-term plans. Finding a financial advisor doesn’t need to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- SmartAsset’s 401(k) Calculator can tell you whether your retirement saving plan is on track.
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