Why Does My 401k Not Allow Loans?

Many participants assume that borrowing from their retirement account is a standard feature. This is a common misconception, as employers are not required to offer a loan provision. The choice to include or exclude this feature is a decision made by the employer when they design the plan.

Employer Discretion in Plan Design

Federal law provides a framework for how 401(k) plans operate, but it grants employers significant flexibility in selecting which features to include. The Employee Retirement Income Security Act (ERISA) and Internal Revenue Service (IRS) regulations set the rules for administering loans if a plan chooses to offer them. For instance, these rules generally cap loans at the lesser of $50,000 or 50% of the participant’s vested account balance.

This regulatory structure does not, however, compel an employer to make loans available. The decision to permit borrowing is an optional provision within the plan’s design. An employer can choose not to include a loan feature from the outset or even amend an existing plan to remove it.

Common Reasons Employers Opt Out

Employers may opt out of offering a loan feature for several common reasons:

• Administrative Burden: Managing a loan program is a significant factor. Processing applications, establishing payroll deductions, and tracking balances require dedicated time and resources that some companies may not be equipped to handle.
• Associated Costs: Plan administration fees can be higher for plans that include a loan feature. A company may determine that the expense of maintaining a loan program outweighs the benefit it provides to employees.
• Fiduciary Risk: Employers act as fiduciaries and have a legal obligation to act in the best interest of participants. If the strict regulations governing loans are not followed precisely, the plan could face penalties, so some employers avoid this added liability.
• Protecting Retirement Savings: Some employers hold a philosophical view that retirement funds should be preserved for retirement. They believe allowing early access undermines this goal and can lead to “leakage” from the retirement system.

How to Confirm Your Plan’s Rules

To get a definitive answer about your plan’s loan policy, you must consult the Summary Plan Description (SPD). This document is a detailed, legally required guide that explains how your 401(k) plan operates, including all its features and rules.

Within the SPD, you should look for a section on participant loans. This section will state whether loans are permitted and, if so, will detail the specific rules, such as minimum and maximum loan amounts, interest rates, and repayment terms. If the SPD does not mention loans, it is a clear indication that your plan does not offer them.

You can obtain a copy of your SPD from your company’s human resources department. Many employers also make this document available through the online portal of the 401(k) plan provider. Logging into your account on the provider’s website often gives you direct access to the SPD.

Alternatives for Accessing Funds

If your plan does not allow loans, you might investigate whether it permits hardship withdrawals. This is another optional plan feature that allows you to take money out of your account for an immediate and heavy financial need, as defined by the IRS. A hardship withdrawal is not repaid to the account and is subject to income tax and a 10% early withdrawal penalty if you are under age 59½, unless an exception applies.

These withdrawals are governed by strict criteria, and you must provide documentation to prove your need. Common qualifying events include certain medical expenses, costs related to purchasing a principal residence, tuition payments, and expenses to prevent eviction or foreclosure. Some plans may also permit penalty-free emergency withdrawals of up to $1,000 per year, which can be repaid within three years. The SPD will detail which withdrawal options are available.

Beyond your retirement plan, you may consider other financial products. Personal loans offered by banks and credit unions are one possibility. Another option for homeowners could be a home equity line of credit (HELOC), which allows you to borrow against the equity in your home. These external options have their own qualification requirements and interest rates.