web analytics

How to Take a 401K Loan?

It’s happened to the best of us. One minute everything is fine, the next you’re staring into the face of a rather large and unexpected bill and you have no idea how you are going to pay for it. Unforeseen events can wreak havoc on our financial well-being and force us to do things we might not otherwise do with our money. If this is you, you might have options. If you’ve been contributing to your employer’s retirement plan, you may have the option of taking a 401k loan.

Note that while most plans do allow loans, they are not required to offer them. Talk with your benefits office or 401k provider to be sure.

Also, keep in mind that just because you do have a loan available to you, that does not necessarily make it the best option if you happen to need money. Many times, it’s the completely wrong thing to do. Loans are considered a benefit in a 401k plan, but they are intended to be used in “last resort” situations. You should also familiarize with the consequences related to defaulting on a loan from a 401k plan, in addition to the available repayment options and the interest rates and fees charged on such loans.

If you do have a strong financial need for it, you should probably consider it. Unfortunately, we’ve seen retirement funds depleted in the form of loans for things like vacations and home remodels; not exactly the reasons they were intended for.

Be wise. If you’re considering a loan, try to limit its use to help you through times of financial hardship. These might include prevention of eviction or foreclosure on your place of residence, medical expenses that are outside the realm of your ability to pay, or repairing damage to your home caused by natural disasters. These are just ideas. Of course, every situation is different, and some things are more urgent to some people than others. Use your own judgment regarding the severity of your particular situation.

On the other hand, if you’re trying to fund your trip to Hawaii, or if you’ve been eying that high-definition T.V., a loan from your 401k should be the furthest thing from your mind. If you can’t afford it from the money in your savings account or other non-retirement account, you shouldn’t be buying it anyway.

Do you have questions about 401k loans? We probably have the answer!

Borrowing from 401k Plans

While borrowing from 401k plans may be an option for you, you cannot obtain an unlimited amount from your account. Rather, the IRS has established rules that allow a plan participant to take no more than 50% of his or her vested balance up to a maximum of $50,000 in a rolling 12 month period. In other words, take the highest cumulative loan balance you’ve had in the last 12 months and subtract it from $50,000. That is your maximum available.

Your employer may have established additional rules such as a limit on the number of loans you can have outstanding at any one time, a maximum number of loans you can take each year, or a minimum loan amount you must take in each instance (usually $1,000). Some employers don’t even allow borrowing from 401k plans, and some have restrictions depending on the type of contributions you can borrow against (i.e. employer match, profit sharing, etc.)

Let’s see some examples:

Judy has a vested balance of $20,000 and wants to take the maximum loan available to her in her 401k. This one’s easy because, if you remember, a participant can borrow no more than 50% of their vested balance.

In this case, the maximum that Judy can borrow is $10,000.

John has a vested balance of $230,000 and wants to take the maximum loan that is available to him. This one’s a little trickier. Remember that although you can borrow up to 50% of you vested balance, you are limited to a maximum of $50,000.

In this case, the maximum that John can borrow is $50,000.

Jane has a vested balance of $125,000 and already has two loans outstanding which she has had for a couple of years. Loan 1 has a current balance of $10,000, and loan 2 has a current balance of $15,000. How much is available?

If you said $25,000(the max. $50k minus the total outstanding of $25k), you are close, but not exactly correct. Remember, the maximum of $50,000 is reduced by the highest cumulative loan balance you’ve carried within the last 12 months.

Let’s say that 12 months ago, Jane’s two outstanding loans were valued at $32,000. You would then simply subtract $32k from $50k to get the amount available. In this case she would have $18,000 available, not the $25,000 you may have initially thought.

As you can see, if you decide to go borrowing from 401k plans, there are some restrictions set forth by both the IRS as well as your employer. Talk to your employer or 401k provider to get find out exactly how much is available to you.

© 2024 About401K.com - Theme by WPEnjoy · Powered by WordPress