Your employer technically will always know when you borrow money from your 401(k). One of the tricky parts about managing a 401(k) loan is that, even though this money belongs to you, your employer can set terms and conditions around taking the loan. The employer may even disallow loans completely. Here’s how 401(k) loans work and what you should keep in mind if you’re thinking about taking one. A financial advisor can help guide you through the process of taking a 401(k) loan or recommend alternatives.
What Is a 401(k) Loan?
A 401(k) is a tax-advantaged retirement account that your employer provides. Money is deducted from your paycheck and saved in the account on a pretax basis. This lets you invest a full dollar for every dollar you earn, unlike the rest of your income on which you pay taxes and only keep a portion of those earnings.
This tax-advantaged status means that you ordinarily cannot sell assets and withdraw money from your 401(k) until you near retirement age or meet the qualifying criteria for a hardship withdrawal. If you do, the IRS will require you to pay the taxes you would have paid on the income you invested along with a 10% early withdrawal penalty.
If your 401(k) provider allows it, you can borrow money from the account with a 401(k) loan. Unlike a hardship withdrawal, you must repay this money back into the portfolio. If you make regular payments and repay the money on time, often within five years, you do not have to pay any taxes or penalties on the loan. But if you fail to repay the loan on time, the IRS will consider it an early distribution and you’ll owe taxes and penalties on the money you borrowed.
A 401(k) loan can be a good way to solve pressing financial problems, such as unexpected job loss or a sudden emergency. While it’s sometimes referred to as an interest-free loan from yourself, this is not accurate. When you take money from your 401(k) you lose out on any growth that this money would have had during the loan period. This is a real loss, one that grows the longer you take to put the money back in.
Your Employer and a 401(k) Loan
The rules governing 401(k) loans aren’t universal – they can vary from plan to plan, employer to employer. Unlike hardship withdrawals, which are generally defined and governed by the IRS, the terms of 401(k) loans are set by your employer when the program is established.
This means that your employer can decide:
- If their 401(k) program will allow loans at all;
- If their 401(k) program will allow loans freely, or only under certain conditions;
- If there are conditions, what those conditions are;
- The maximum amount of a loan (up to 50% of the account’s value);
- Some repayment terms
As part of running and managing the 401(k) program, your employer will have an officer or agent who monitors all contributions, withdrawals and other aspects of the plan. This person is known as the “record keeper.” He or she may be an employee of the company or work for an external firm that the company hires to run the 401(k) program on its behalf.
On an institutional level, your employer has access to these records. This means that every withdrawal from an employee 401(k), including loans and hardship withdrawals, can be known by certain company employees.
However, it’s important to note that this does not mean your immediate supervisor or any specific colleagues will have access to this information. The details of a 401(k) plan are generally considered confidential financial information, so it’s likely that your company will have rules around who can see those records. The smaller your firm, the more likely it is that a close colleague will have access to 401(k) records. At a larger company, though, it’s likely that only finance or human resources personnel, along with upper management, will have the right to see those records.
In either case, the answer is the same though. Yes, your employer as an institution will know if you take out a loan from your 401(k) portfolio. However, that information is not necessarily available to any specific colleague.
Your employer sets the rules for taking loans out of its 401(k) program, which means that as an institution certain employees will have the ability to know every withdrawal and loan that someone makes. However, that does not mean that any individual manager or coworker will have access to this information.
Retirement Savings Tips
- Keep the IRS contribution limits in mind each year and max out your retirement accounts when you can. If you have a 401(k), 403(b) or 457 plan, you can contribute up to $22,500 to your account in 2023, plus another $7,500 if you’re 50 or older. You can save another $6,500 in an IRA ($7,500 if you’re 50 or older).
- A financial advisor can help you build a comprehensive retirement plan. Finding a financial advisor doesn’t have 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.
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