401K Loan and Hardship Withdrawal Rules
401k retirement plans are intended to grow tax-deferred, with no
withdrawals until you hit retirement age. However, since we don't
live in a perfect world, especially with the recent economic
environment and layoffs. As a result, items may come up that
require you to have immediate available funds in the event of the
death of spouse, big medical bill, etc. Regardless, there is an
opportunity to withdraw money from your 401k or other retirement
401k Loan Benefits:
The primary benefit of acquiring a
from your retirement plan is that the proceeds of this loan are
exempted from taxes and without penalty. There are no restrictions
on the use of a 401k loan acquired from your plan. However, some
plan administrators have implemented a few details like number of
outstanding loans and the minimum balances associated with that
amount. In a nutshell, companies do this to decrease the amount of
administrative costs that they incur.
Limits of Loan from 401K Plan
When would a
provide a reasonable solution for your needs? The typical
stipulations of 401K borrowing allow you to take up to 50% of your
retirement plan balance or $50,000, whichever is less. You are
typically required to pay the loan back within a period of 5 years.
There is some reasonable thoughts you need to exercise when putting
this decision into effect. A
for hardship is a valid approach provided that it is not a
distribution. Don't forget, there is a distribution penalty on all
loans taken from a retirement plan.
Interest on 401K Loans
The laws that relate to a
do not place any restrictions on the use of the proceeds, expect
that the loans must be made available to all employees. However, a
company can restrict the reasons for these loans if they choose to
do so. A few businesses have declared that loans are restricted for
the purposes of preventing eviction from your home, paying amounts
for higher education, or paying for health expenses. Generally
speaking, employers offering a 401K loan provision will restrict
the number of loans. Usually, the amount of the loan is deducted
from the employee's income each week and the interest rate is
charged at the prime rate plus 1%.
What to Think About Before Taking a 401k Loan.
Other factors things to think about when pondering whether or
not to take a
include, but are not limited to:
- If you are planning to leave your job, often the unpaid loan
will be automatically labeled as income. The amount that was
borrowed could then be subject to both income tax and the 10%
401K penalty. You can be effectively losing interest on the
amount of the distribution.
- Payments to satisfy a loan from your 401k come from after tax
dollars. Amounts you contribute to the loan has quite a bit of
opportunity costs when compared with lost investment potential or
interest earning activity.
As previously mentioned, there are many positives to taking a
401K loan. Credit checks are non-existent and the process for
getting the loan is relatively seamless. In addition, when you pay
back the loan interest you are really just paying yourself and the
interest associated with the transaction is tax sheltered. You
don't pay taxes on the interest on the loan until retirement.