401k Loan Rules

The 401k loan rules are a set of guidelines you must follow when taking out a loan from your 401k. There are standard rules which all plans must follow, and each individual plan may have their own rules as well.

First of all you may only take out a loan if your account has reached a certain level and you can only take out 50% of the amount in your 401k. During this time you may not be able to contribute more money into your 401k (depending on the plan), and you are required to make regular payments.

If you lose your job you may be required to pay back your loan in full within a short period of time, or it will be counted as a 401k withdrawal, in this case you will be hit with an early withdrawal penalty and be required to pay taxes on the money.

Why Would Someone Take a Loan?

So why would someone take out 401k loans? Even though a loan from your retirement plan should be the last resort there are some advantages to it.

1. Lower Interest Rate

A loan from your retirement plan will most likely come with an extremely low interest rate compared to what the banks will give you. This does make it a little attractive.

2. No Credit Check

Because you are borrowing money from yourself you do not need to get your credit checked. So even if your credit score is 451 you can still get approved.

3. Get Cash Now

When you take out a loan from your 401k you get cash instantly. You do not have to wait around to get approved. This can be great if you absolutely need to pay some bills that are right around the corner.

Disadvantages of the loan

The 401k loan rules are built to discourage people from taking loans, so there are a number of disadvantages.

1. Missing Out

If you take a loan you are hurting your retirement plan in 2 ways, your money is no longer growing in the account and you may not be able to deposit more money.

Many plans will either not allow you to deposit more money once you have token out a loan or they will limit the amount you can deposit. This can severely impact the amount you will have when you retire.

2. Lower Paycheck

Because of the loan you will end up with a much lower paycheck. Taking on more bills is not something that you need especially when you are in a financial crisis.

3. You May Have to Pay it Back Faster

If you leave your job you may have to repay the amount at a much faster rate. Instead of having 5 years to repay it you might have to repay it in the next month or two, giving you even greater financial stress.

4. If You Can’t Pay it back

If you can’t pay it back it may be considered an early withdrawal in which case you will get hit with penalties and have to pay taxes on the money.

Should I take a Loan?

Taking a loan from your 401k plan should be a last resort, not something to help you remodel your house, but maybe something to save you from losing your house. As always make sure that all other options are considered first.

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