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For most of us, our 401k plans are the first and only place we have reserved for consistent and "real" savings - money we put away and never intend on touching until retirement. But what happens if we're faced with an unexpected expense? Is getting a 401k loan possible?

Taking Out a 401k Loan

Before we answer the question "Can I get a loan from my 401k?" Let's talk briefly about the question "Should I take a loan out of my 401k plan?" Most financial planners would answer this second question with a simple "No."

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That's because taking out a 401k loan is like borrowing against your financially-secure retirement. They'd argue that money in your 401k account serves only one purpose - a source of retirement income. But most decisions we're faced with in life are not so black and white.

Of course there are ways to borrow money from your 401k plan, and we're going to talk about how to go about doing so shortly. But we have to agree with financial planners on this point with one slight modification. If you're going to get a 401k loan, it really should be for a very good reason - almost as a last resort.

401k Loan Rules

Over the course of this article we are going to discuss true 401k loans. You can always take money out of your 401k plan, but the income tax penalties will make that experience very unpleasant and costly. Fortunately, the IRS does allow you to borrow money from your 401k plan, in the form of a loan, and without any taxation penalties.

Acceptable 401k Loans

But in addition to the IRS, you also need to deal with your 401k plan administrator to figure out the exact terms and conditions of a 401k loan - including if it is allowed under your particular plan. Generally, the following are considered acceptable reasons for taking a 401k loan:

College Tuition - to pay for higher education / college tuition expenses for you, your spouse, or your children.
Home Mortgage - to prevent yourself from eviction from your home due to unpaid mortgage bills or possibly bankruptcy.
Medical Expense - to pay any un-reimbursed medical expenses that you might have incurred. This type of loan would be considered a hardship loan.
First Time Home Buyer - to put a down payment on a new home or residence when you're a first-time home buyer.

If you're looking for a 401k loan to pay your monthly credit card bills, you'd be better off looking elsewhere. In fact, you might be better off just taking a hard look at your household budget. You don't want to borrow from your retirement funds to pay for today's expenses.

Typical 401k Loan Rules

As mentioned earlier, while the federal government might allow you to borrow money from your 401k plan, the plan administrator will have repayment rules that you need to be aware of before taking out a loan. Typical 401k loan rules might include:

Length of Loan - typically the loan term would be five years (60 months) or less. In the case of a home loan, terms could be as long as 15 years.
Loan Minimum - loan thresholds are usually $1,000. And quite frankly loans of lesser amounts shouldn't even be considered from a 401k account.
Loan Maximums - usually the lesser of 50% of the account balance or $50,000.
Loan Fees - 401 plans can charge fees for loans including loan initiation fees and annual service charges.
Repayment - repayment typically occurs evenly over 60 months, although as mentioned, 401k loans beyond 60 months are possible. Repayment usually is accomplished via direct payroll deduction.

And like most loans, there are some pros and cons that come along with a 401k loan.

Pros of 401k Loans

Applying for a 401k loan is usually a very simple process. Most times you can arrange for a loan simply by calling the plan administrator.
Any interest you pay on the loan goes back to your account. That is to say, you keep the interest you're required to pay on the loan.
Interest rates are usually very competitive for 401k loans, even if you have poor credit. After all, you're borrowing your own money, so that limits non-payment risk.

Cons of 401k Loans

Perhaps the biggest drawback of a 401k loan is the fact some plans do not allow you to contribute to your 401k until the loan is completely repaid. So if your employer matches your 401k contributions, you're missing out on some "free" money until the loan is repaid.
The interest rate / expense paid on a 401k loan is not tax deductible.
The term of the loans - five years / 60 months - is relatively short when compared to alternatives such as personal loans.

And on that last point, it's worth mentioning some of the alternatives you have to 401k loans.

Alternatives to 401k Loans

If you're considering taking out a 401k loan to pay for college tuition or medical expenses, you do have some pretty good alternatives:

Home Equity Loans / Lines of Credit - one of the big benefits of a home equity loan is that the interest portion of the payment is usually tax deductible. Plus, the length of the loan, or payment term, can be much longer (greater than 60 months) with a home equity loan when compared to a 401k loan.
Federal Student Loans - if you're a student or parent of a college student, you might want to consider borrowing through one of the many student loan programs offered by the federal government before you borrow against your 401k plan. You'll often find the payment terms and interest rates on a student loan to be very low when compared to other types of loans.

Finally, if you're still thinking about taking out a 401k loan, you might want to use some of our 401k and retirement calculators to help figure out if you're 401k plan is financially healthy. You can also use one of our many loan calculators to help calculate your monthly payments on a 401k loan.

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