Can I Take a Loan From My 401(k) Plan?

A 401(k) plan is primarily for retirement savings, but some plans allow participants to borrow against their vested account balance. This functions as a loan from your own savings, requiring repayment to the account. It provides temporary access to funds without immediately incurring taxes and penalties associated with early distributions.

Understanding Loan Eligibility and Limits

Not all 401(k) plans offer a loan feature; availability depends on the employer or plan sponsor. If permitted, eligibility extends to active employees with a vested account balance. The Internal Revenue Service (IRS) sets limitations on the amount an individual can borrow. Generally, the maximum loan is the lesser of 50% of the vested account balance or $50,000. Some plans may also impose a minimum loan amount, such as $1,000.

The repayment period for a 401(k) loan is typically limited to five years. A longer term may be allowed if the loan is for a primary residence. Interest is charged on the loan, and the interest paid is returned to the participant’s own 401(k) account.

Plans vary on whether they permit multiple outstanding loans. Some allow only one loan at a time, while others permit multiple loans if the total outstanding balance does not exceed IRS limits. For married participants, some plans may require spousal consent for a loan, often involving a signed and notarized form.

Repaying Your 401(k) Loan

Repaying a 401(k) loan is commonly done through automatic payroll deductions. These deductions typically occur on a bi-weekly or monthly basis, aligning with the employee’s pay schedule. Payments include principal and interest, amortized over the loan term, ensuring the loan is fully repaid by the designated deadline.

Participants can repay their loan early or make additional payments without incurring prepayment penalties. If a plan uses payroll deductions, adjustments to the withholding can increase the repayment amount. While a loan is outstanding, some plans may allow participants to continue making regular contributions to their 401(k), while others might temporarily pause contributions until the loan is repaid.

If a participant’s employment with the company ends, many plans require the full outstanding loan balance to be repaid within a specific timeframe, often by the due date of the individual’s federal tax return for the year in which employment terminated. Failure to repay the loan by this accelerated deadline results in a default.

Defaulting on a 401(k) Loan

Failing to repay a 401(k) loan constitutes a default. When a loan defaults, the outstanding balance is treated as a “deemed distribution” from the 401(k) plan. This means the unpaid loan amount becomes immediately taxable as ordinary income in the year of the default.

Beyond income tax, an additional 10% early withdrawal penalty is applied to the deemed distribution if the participant is under age 59½ at the time of default. For instance, a $50,000 defaulted loan could result in a $5,000 penalty in addition to being taxed at the individual’s marginal income tax rate. The plan administrator will report the defaulted loan amount to the IRS on Form 1099-R.

The 401(k) Loan Application Process

Initiating a 401(k) loan application typically begins by contacting the plan administrator, the employer’s Human Resources department, or accessing the plan’s online portal. These resources provide specific details about the loan program, including available loan amounts and terms.

Common information required for the application includes the desired loan amount and the preferred repayment term. For married individuals, if spousal consent is required by the plan, a signed and notarized consent form will be a necessary part of the documentation.

Once the application is submitted, the approval process is generally quick, often taking a few business days. Funds are typically disbursed within 7 to 10 business days of approval. The money can be received through various methods, such as direct deposit into a bank account or a physical check.