For many individuals, their 401(k) plans are the first and only place reserved for consistent and "real" savings. This is money put away, and never touched until retirement. But what happens if someone is faced with an unexpected expense? Is getting a 401(k) loan possible?
Before answering the question "Can I get a loan from my 401(k)?" It's important to address the question: "Should I withdraw money from my plan?" Most financial planners would answer this second question with a simple "No."
That's because taking out a 401(k) loan is like borrowing against a financially-secure retirement. They'd argue that money in the account serves only one purpose: it's a source of retirement income. But most decisions people are faced with in life are not so black and white.
There are ways to borrow money from a 401(k) plan, and that discussion will start shortly. But it's important to emphasize how financial planners feel about loans, with one slight modification. If someone is going to borrow money from an account, it should be for a very good reason; almost as a last resort.
Over the course of this article, the focus will be on true 401(k) loans. It's always possible to take money out of a 401(k) plan, but the federal income tax penalties will make that withdrawal very costly. Fortunately, the Internal Revenue Service does allow taxpayers to borrow money from their plan, in the form of a loan, and without any taxation penalties.
In addition to the IRS, accountholders may also need to speak with their plan administrators to determine the exact terms and conditions of a loan, including if it is allowed under their plan. Generally, the following are considered acceptable reasons for taking out a loan:
Individuals planning to take out a loan to pay their monthly credit card bills should look elsewhere. In fact, they might be better off just taking a hard look at their household budget. It's never a good idea to borrow from a retirement fund to pay for today's expenses.
As mentioned earlier, while the federal government might allow an individual to borrow money from their 401(k) plan, the plan administrator will have repayment rules that employees need to be aware of before taking out a loan. Typical rules might include:
Like most loans, there are some pros and cons that apply when borrowing from an account.
On that last point, it's worth mentioning some of the alternatives to this type of loan.
Individuals taking out a 401(k) loan to pay for college tuition or medical expenses, have some very good alternatives including:
Finally, anyone considering a loan can use one of the many 401(k) and retirement calculators found on this website to determine if their plan is financially healthy. There are also many loan calculators on this website that can be used to determine monthly payments on a loan too.
About the Author - 401(k) Loans (Last Reviewed on October 19, 2016)