What Do You Need for a 401k Loan Application?

Borrowing from your 401(k) provides a way to access cash without a traditional lender. Since you’re borrowing from your own savings, there’s no credit check, and interest payments go back into your account. However, this option comes with rules and risks that should be carefully considered.

Eligibility Criteria

Not all 401(k) plans allow loans; this depends on the employer and plan administrator. Some workplace retirement plans do not offer this option, making borrowing unavailable to those employees.

Employment status is also a factor. Most 401(k) loans are only available to active employees since repayment is typically made through payroll deductions. If you leave your job, you may need to repay the loan in full within 60 to 90 days to avoid taxes and penalties.

Different retirement accounts have varying rules. Traditional 401(k) plans commonly allow loans, but 403(b) plans for nonprofit employees and 457 plans for government workers may have restrictions. Roth 401(k) funds are generally ineligible for loans due to their after-tax funding and different withdrawal rules.

Loan Amount Basics

Federal law limits 401(k) loans to the lesser of $50,000 or 50% of the vested account balance. For example, if your vested balance is $80,000, the maximum loan would be $40,000. If your balance is $200,000, the cap remains $50,000. These limits, set by the IRS under 26 U.S. Code 72(p), prevent excessive borrowing from retirement savings.

Employers may impose stricter limits. Some cap loans at 25% of the vested balance or set a lower maximum, such as $25,000. Reviewing your plan’s rules is necessary to determine your borrowing limit.

If you already have a 401(k) loan, the amount available for a new loan is reduced. For example, if your maximum loan limit is $50,000 and you have an outstanding loan of $20,000, you can only borrow up to $30,000.

Employer Policies

Employers establish additional rules beyond federal regulations. Some require a minimum loan amount, often around $1,000, to discourage small withdrawals. Others limit employees to one outstanding loan at a time.

Repayment terms vary. The IRS allows up to five years for general-purpose loans and longer for loans used to buy a primary residence, but some employers require shorter repayment periods, such as three years. While a shorter term increases monthly payments, it reduces the time the loan remains unpaid.

Interest rates are set by the plan but must be “reasonable” under IRS guidelines. Most employers set rates at the prime rate plus 1% or 2%. The rate is fixed for the life of the loan and outlined in the plan documents.

The Application Process

Applying for a 401(k) loan requires gathering documents, submitting forms, and awaiting approval. Each employer has its own process, but most follow a structured approach to comply with IRS regulations.

Gathering Documents

Employees must provide a recent 401(k) account statement showing the vested balance, as loan amounts are based on vested funds. Proof of employment, such as a recent pay stub, is often required.

For loans used to purchase a primary residence, additional documentation is needed, such as a signed purchase agreement or estimated closing costs. These documents verify that the loan qualifies for an extended repayment period.

Some plans require a spousal consent form if the applicant is married. This is common in plans subject to the Employee Retirement Income Security Act (ERISA), which protects spousal rights.

Submitting Forms

Employees complete a loan application form, usually available through the plan administrator’s website or HR department. The form requires details such as the loan amount, repayment term, and reason for borrowing, though some plans do not require a stated purpose unless the loan qualifies for an extended repayment period.

Many employers allow online applications, while others require paper forms. Some plans mandate a consultation with a financial advisor before processing large loans or applications from employees with multiple past loans.

After submission, the plan administrator reviews the application for compliance with IRS regulations and plan policies. Missing or incorrect information can delay or result in rejection, so applicants should double-check all details before submission.

Approval Timelines

Processing times vary. Many approvals are granted within a few business days, especially if the plan offers an automated online system. Manual reviews, such as those for home loans or spousal consent cases, can take one to two weeks.

Once approved, disbursement depends on the plan’s payment policies. Some employers issue funds via direct deposit within a few days, while others process payments through payroll, which may delay disbursement until the next pay cycle.

If an application is denied, employees may appeal or submit a revised request. Common reasons for denial include exceeding loan limits, failing to meet employment requirements, or missing documentation. Understanding the reason for rejection helps applicants correct issues and reapply.

Repayment Terms

401(k) loan repayment follows IRS regulations and employer policies to ensure borrowed funds are restored to the account. Missing payments can lead to financial penalties.

Frequency of Payments

Most 401(k) loans are repaid through payroll deductions. The IRS requires payments at least quarterly, but most employers set biweekly or monthly payments to align with payroll cycles.

For home loans, repayment terms may extend beyond five years, but payments must follow a set schedule. Some plans allow early repayment without penalties, but employees should confirm whether lump-sum payments are permitted.

Payment Methods

Since payments are deducted from payroll, employees usually do not need to take additional action. However, if an employee takes unpaid leave, some plans allow temporary payment suspension, provided the loan is repaid within the required timeframe.

If an employee leaves the company before repaying the loan, options become limited. Some plans allow continued payments via direct deposit or check, but many require full repayment within 60 to 90 days. If not repaid, the loan is treated as a distribution, triggering taxes and penalties.

Default Consequences

Missing payments can have financial consequences. If a borrower fails to make payments and does not catch up within the plan’s grace period, the outstanding balance is considered a “deemed distribution” by the IRS. This means the unpaid amount is treated as taxable income for that year. If the borrower is under 59½, an additional 10% early withdrawal penalty applies.

A defaulted loan also reduces retirement savings, as the borrower not only loses the borrowed funds but also misses out on potential investment growth. Unlike traditional loan defaults, a 401(k) loan default does not affect credit scores, but the tax burden and penalties can create financial strain.

Tax Obligations

401(k) loans are not initially taxed, but they have tax implications. Loan repayments are made with after-tax dollars, meaning the money is taxed again when withdrawn in retirement. This results in a form of double taxation.

If a loan is not repaid and is classified as a deemed distribution, the borrower must report the outstanding balance as taxable income. This can push them into a higher tax bracket, increasing their overall tax liability. If under 59½, they also face a 10% early withdrawal penalty.

For Roth 401(k) accounts, loan repayments do not have the same tax implications since contributions are made with after-tax dollars. However, most plans do not allow loans from Roth balances. Borrowers should review their plan’s tax treatment and consult a tax professional if unsure about the financial impact.