The answer to this question will vary by employer, but generally loans are allowed. We suggest you contact your plan administrator for the specific details of your particular plan. 401k loans are allowed under the law, but not all employers will offer this option. Even if they are allowed under your plan, this may not be the best solution depending on your particular financial needs. In fact, 401k loans are often considered a last resort option because of the risks they pose to the financial health of your retirement account. Depending on your particular situation, it may be advisable to consider a 401k loan only if other sources have been exhausted.
Typically there are restrictions placed on the acceptable reasons for a 401k loan and again this is a conversation for your plan administrator. However, in most cases, 401k loans are allowed for college tuition, first time home purchases, home mortgages, or emergency medical expenses. The logic behind these restrictions is that 401k loans should not be used in everyday circumstances, but in extenuating circumstances. In general, an employee can borrow up to 50% of the vested account balance up to a maximum of $50,000.The loan must be paid back over the next 5 years, sometimes longer for housing loans.
A 401k loan can seem like a convenient option with many benefits. The interest rate is usually highly competitive and the interest paid will go directly into your 401k account. However, a 401k loan can be inflexible and poses long-term financial risks. It is often not advisable if you may soon retire or lose your job. If you leave your job before repaying the loan, then your employer can increase the timetable for loan repayment, usually within the next 60 days. Thus, a 401k loan is not advisable without high job stability.
While the loan is outstanding, your retirement account may be put on hold, limiting the ability to contribute to the account. This can have a negative effect on the overall health of the 401k portfolio and your individual financial situation, as you lose the ability to deduct contributions from your taxable income. In addition, when you take out a 401k loan, you are removing money that would otherwise be earning a return via appreciation, interest, or dividends. In addition to losing this immediate gain, you also decrease the compound return you would earn over time. Another drawback of a 401k loan is that the interest rate paid on the loan is not tax-deductible. This is not ideal, compared to other loan options like a HELOC, where the interest on the loan is tax-deductible. Finally, the repercussions for failing to repay a 401k loan are severe, you are subject to the early withdrawal penalty of 10% of the current balance of the account. We encourage individuals to research available options outside of a 401k loan and consult a financial professional before making a final decision.
** The information provided should not be interpreted as a recommendation, no aspects of your individual financial situation were considered. Always consult a financial professional before implementing any strategies derived from the information above
401(k) plans are like cars. They have basic features and options. Whether your 401(k) plan allows for loans depends on whether your employer decided to offer the option.
Contact your HR department. They should know whether loans are allowed on your plan. If they do not know, then contact the administrator for the plan (HR should be able to provide you that information, or check Brightscope for the information).
I should point out that if you are no longer with the employer, you will likely not be able to take a loan. I have only seen one situation where an employee no longer with a company was able to keep an open loan at a former employer's plan. He made payments to the plan via check as if it were a regular loan. I have not heard of anyone able to initiate a loan from a former employer's 401(k) plan.
Hi Antonio, Russ makes several fine points. Here are a few additional ones to consider:
While you have a loan outstanding from your 401k, you cannot make additional pre-tax contributions. So having a loan effectively puts your retirement savings on hold, at least until you repay the loan.
The tax consequences of a 401k loan are very unfavorable and even very expensive. 401k loans are repaid with after-tax dollars (whereas normal contributions are pre-tax, as I mentioned above). So those loan repayment dollars have been taxed once. But when you retire, and and all money coming out of your 401k (whether it is contribution money, repaid loan money, earnings on your investments, etc.) will be taxed again as ordinary income. That means your loan money will effectively be taxed twice! And that makes a 401k loan VERY expensive, regardless of how low the interest rate on it may be.
Just some additional points to consider in your decision-making process. Mike
One point to clarify on Michael's answer. If you have to take a "Hardship Loan", you are not able to make further contributions to your account for a certain period of time.
Most 401k plans have loan provisions, but they can differ considerably. Utilize your plan administrator to help with your current situation.