How Many 401(k) Loans Can You Take Out?

A 401(k) loan offers individuals a way to access a portion of their retirement savings without incurring immediate taxes or penalties. This financial tool allows participants to borrow money from their own account, providing a potential source of funds for various needs. Unlike traditional loans, a 401(k) loan does not involve an external lender or require a credit check. The interest paid on the loan typically returns directly to the participant’s retirement account.

Understanding 401(k) Loan Limits

The number of 401(k) loans an individual can take out simultaneously is determined by the specific rules of their retirement plan. While federal regulations do not set a universal limit on the number of loans, many plans restrict participants to one or two outstanding loans at any given time. Individuals should consult their plan’s summary plan description or contact their plan administrator to understand these specific limitations.

Federal law imposes limits on the maximum amount that can be borrowed from a 401(k) account. The loan amount cannot exceed the lesser of $50,000 or 50% of the vested account balance. For example, if a participant has a vested balance of $75,000, the maximum loan would be $37,500, which is 50% of the balance.

An exception to this rule allows participants to borrow up to $10,000, even if 50% of their vested balance is less than this amount. When considering multiple loans, the total outstanding balance of all loans must remain within the federal limits.

The $50,000 limit is subject to a look-back rule, which considers the highest outstanding loan balance over the preceding 12-month period. To calculate the current maximum, the highest outstanding balance from the past year is subtracted from $50,000. This adjusted figure then becomes the maximum allowable total loan balance, including any existing loans and the proposed new loan.

Repaying Your 401(k) Loan

A 401(k) loan is repaid through regular deductions directly from the participant’s paycheck. These payments include both principal and interest, and they must be made at least quarterly to comply with IRS guidelines.

The standard repayment period for a 401(k) loan is up to five years. If the loan proceeds are used to purchase a primary residence, the repayment term can be extended, potentially up to 10 or 15 years, depending on the plan’s provisions.

Interest paid on the borrowed amount is returned to the participant’s own retirement account. Unlike traditional loans where interest goes to an external lender, here the borrower effectively pays interest back to themselves. This can help mitigate some of the opportunity cost associated with removing funds from investments.

If employment terminates while a 401(k) loan is outstanding, the repayment terms change. Plans require the remaining loan balance to be repaid in full by the tax-filing due date of the following calendar year, including any extensions. Failure to meet this accelerated repayment deadline can trigger severe financial consequences.

What Happens if a 401(k) Loan is Not Repaid

Failure to repay a 401(k) loan according to the agreed-upon terms leads to financial and tax implications. When a loan is not repaid on time, the outstanding balance is treated as a “deemed distribution” from the 401(k) plan. This means the unpaid amount is considered an actual distribution, even though no money is physically disbursed.

Once a loan is deemed distributed, the entire outstanding balance becomes taxable as ordinary income in the year of the default. This taxation applies regardless of the participant’s age. If the participant is under age 59½ at the time of the deemed distribution, an additional 10% early withdrawal penalty tax applies to the taxable amount.

The deemed distribution impacts the participant’s retirement savings. The defaulted loan amount is removed from the account’s investable balance, ceasing its potential for future tax-deferred growth. While the participant remains obligated to repay the loan to the plan, the amount has already been taxed, and subsequent repayments are considered after-tax contributions.

Before a loan is declared in default, plans offer a “cure period” or grace period, extending until the end of the calendar quarter following the missed payment. This period provides an opportunity for the participant to catch up on missed payments and avoid the adverse tax consequences of a deemed distribution.

Steps to Obtain a 401(k) Loan

Before applying for a 401(k) loan, individuals should verify if their specific plan permits loans, as not all 401(k) plans offer this option. This information can be found in the plan’s summary plan description or by contacting the human resources department or plan administrator. Understanding the plan’s specific rules, including any minimum loan amounts or additional restrictions, is a first step.

Gathering necessary information includes determining the desired loan amount, the preferred repayment term, and the purpose of the loan. Spousal consent may also be required for the loan to proceed.

The application process for a 401(k) loan begins by accessing the plan’s online portal or contacting the plan administrator. Plans facilitate the application electronically, allowing participants to fill out forms and submit requests digitally.

Once the application is submitted, it undergoes a review process, which takes a few business days. If approved, the participant receives a promissory note for review and electronic signature. Loan funds are then disbursed, via direct deposit to a bank account or by check, with processing times varying but taking several days to a few weeks from submission to receipt.