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Can I borrow money from my 401k?

Jun 14, 2013 by Joseph from Englewood, CO in  |  Flag
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Peter C. Karp Level 20

Joseph,

Borrowing from your 401(k) should be your last resort. Explore other options first as it can be very difficult to make up for the lost earnings you can obtain in your 401(k) and it will impact your retirement income. If you must borrow for your 401(k) you need to first contact your HR department to find out if they offer a loan provision. Keep in mind that when taking a loan from your 401(k) there are certain rules, such as you can only borrow the lesser of 50% of your vested balance or $50,000. You repay the loan through salary deductions with interest with after tax dollars. Because of the cost, many plans also set a minimum amount (often $1000) and restrict the number of loans any participant may have outstanding at one time. If you default on the loan any unpaid balance will be classified as a distribution and you would be subject to income tax and may also be subject to a 10% withholding penalty. Remember, the purpose of a 401(k) plan is to fund your retirement, so don’t shortchange your golden years by treating it as a checking account.

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Comment   |  Flag   |  Jul 12, 2013 from San Francisco, CA

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Alex Bentley Level 18

Probably. But it is a really bad idea. Do yourself a favor and don't do it. Find the money elsewhere.

Comment   |  Flag   |  Jun 14, 2013 from Pacific Palisades, CA

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When an employer sets up a 401(k), they have an option to provide loans in the plan document. If the plan document says you can have loans, then basically, you can borrow up to 50% of your vested balance, up to $50,000.

With that said, unless it is an absolute dire emergency, it is a really, really, bad idea. First, there is the premise that Uncle Sam allows you the tax advantage of a 401(k) for the purpose of encouraging you to save for retirement. Money that goes in is earmarked for your retirement. However badly you think you need this money now, just wait till you get to retirement. Short of a large inheritance or hitting the lottery, it is almost certain you will need it more then.

Second, you will be subject to double taxation. You would be withdrawing pre-tax money, but will have to pay it back with after-tax dollars. And if you default or lose your job, you will have to pay income tax plus a 10% penalty.

As difficult and uncomfortable as it feels, you need to develop discipline and have a financial plan. Unless it is well thought out and there is a true need, you should never take a loan on your retirement.

Comment   |  Flag   |  Jun 14, 2013 from Delray Beach, FL

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Joseph,

You may be able to borrow from your 401(k) if the plan allows for it. 401(k) loans are a provision that a plan sponsor (your employer) can choose to either include or exclude in the plan. Consult your employer or HR department to find out if the plan allows for loans. If it does allow for loans, you will also need to ask how much you are eligible to borrow. Some plans only allow a participant to borrow from certain "sources" in the plan. For example, you may only be able to borrow from the amount of money you personally deferred into the plan, and not any of the employer contribution. Regardless of sources, by law you can only borrow the lesser of 50% of your account balance, or $50,000.

Assuming your plan allows for loans and you choose to initiate one, it must be paid back, with interest. Some people believe that they are wise for taking a 401(k) loan because the interest on that loan is paid back to their own account. They consider it a wise investment because "paying themselves." Generally, loans cannot be taken out for longer than 5 years, and the interest rate will be in the 4-5% neighborhood. Again, check with HR for specifics on your plan.

Be cautious with 401(k) loans for two reasons: 1. If you don't pay the loan back (for example, if you lose your job and can’t pay the loan back immediately) the loan becomes income to you. That means that the outstanding balance will be taxable, including early withdrawal penalty if you are under age 59 and ½ .

  1. If someone is borrowing from their 401(k), often it is because they don't have adequate savings, and can't borrow money anywhere else. Debt, from any source, is a difficult cycle from which to break free. I would give serious consideration to why you need the loan in the first place, and what moves you should be making financially to avoid excessive debt.

Hope this was helpful!

-Ted

1 Comment   |  Flag   |  Jun 14, 2013 from Bay City, MI
Ted Schumann II CFP®

Sorry about the formatting, I wrote this in Word and tried to copy and paste.

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Flag |  Jun 14, 2013 near Bay City, MI

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If all else fails, depending on your age, amount in your 401k and the plan itself, you may be able to set up what is called a substantially equal periodic payment, sometimes referred to as 72(t), the IRS code to which it refers. It could help you avoid the 10% penalty on a withdrawal, but I only recommend it as a very last resort and only if it would work based upon your situation. Since, it should only be as a last resort, and is truly very complicated, I won't get into the details here, and stress that if you were to consider it, you should seek the help of a qualified financial and tax professional to do it.

Comment   |  Flag   |  Jun 17, 2013 from Malvern, PA

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The 72(t) could be a workable strategy, but probably based on your age, it won't generate the kind of cash you are looking for. At least that has been my experience with working with 72(t). I guess I am making the assumption you are under 50 Joseph. But repeating the above, don't do this if you don't have to. Failing to repay a loan such as this will, possibly, result in a sizeable tax bill.

1 Comment   |  Flag   |  Jun 17, 2013 from Oshkosh, WI
Angeline

Probably you can borrow money from it yet, I advise you not to do it. Try to find money somewhere else. In spite of 401(k) loans making good financial sense in theory, the number of 401(k) loan defaults is still higher than normal. Many people have trouble paying them back once they take from their retirement funds. Source for this article: 2011 tax payment grace

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Flag |  Jul 15, 2013 near Los Angeles, CA

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