Repaying your 401K Plan Loan

If you do borrow against your 401k, you will need to understand the 401k loan repayment process. The amount of time in which you have to a pay a loan back will vary depending on the type of loan you get. There are generally two types of loans: general purpose, and principal residence. If you need a refresher, you can go here to review these two types of 401K loans.

If you take a general purpose loan, expect to have the 401k loan repayment last no more than 5 years from when you take it out. This is a hard and fast rule—there are no exceptions to this. The IRS has set very strict rules regarding this. Since the average person changes jobs every few years, there is a distinct possibility that you will move to another job within that 5 year period and be required to pay the loan back in full or face a default. Be careful. (okay, so there are some exceptions, especially if you are on a leave of absence.)

Principal residence loans have much longer repayment terms. Many principal residence loans can be taken out for up to 30 years; the same length as a mortgage. This is an incredibly long time, please refrain from doing this! Not only are your chances of defaulting the loan much greater (you don’t expect to be working for the same company for 30 years, do you?), but you will simply kill the return on your 401k investments.

If you can’t adhere to the 401k loan repayment policy, or you separate from service and can’t pay the loan back immediately, the loan will be defaulted or deemed, and you will pay taxes on the default as ordinary income.

When requesting the loan you can generally choose any length of time that you wish to have the loan outstanding, within the specified limits of the plan. Keep in mind that some plans limit the increments in which the loan can be taken. For example, a plan may allow you to take the loan for any period of time in monthly increments; others may require 6 month increments, or even yearly increments. You’ll need to talk with your benefits office or plan provider for details.

Before you take a loan, you should always ask yourself if you think you will still be working for the same company while you are still repaying your loan. Or, you should ask yourself if you will be able to pay it back if you do leave. If the answer is no, then taking a 401k loan is probably not a good idea.