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In the 401(k) industry, a loan refers to the ability of participants to borrow money from their own 401(k) account balance. Here are some key points about 401(k) loans:

  1. Loan Limits: Typically, the maximum amount that an individual can borrow is either $50,000 or 50% of their vested account balance, whichever is less.
  2. Repayment Terms: Loans usually must be repaid within five years, with payments made at least quarterly. The repayment term may be extended if the loan is used to purchase a primary residence.
  3. Interest: Borrowers pay interest on the loan, but the interest is credited back to their own 401(k) account, so they’re effectively paying the interest to themselves.
  4. No Credit Check: Since the loan is secured against the borrower’s own 401(k) funds, there is no credit check required to take out a 401(k) loan.
  5. Tax Implications: There are no immediate tax implications as long as the loan is repaid according to the plan’s terms. However, if a borrower fails to repay the loan, it is treated as a distribution and is subject to taxes and potential penalties.
  6. Impact on Retirement Savings: While a loan may provide a source of funds without an early withdrawal penalty, it can negatively impact retirement savings. The money borrowed does not benefit from potential investment growth while it is out of the market.
  7. Plan Provisions: Not all 401(k) plans allow loans and those that do have specific rules that govern them. Participants must check with their plan administrator to understand the specific rules that apply to their 401(k) loans.
  8. Continued Contributions: Participants are typically allowed to continue making contributions to their 401(k) while they have a loan, but some plans may limit this ability.
  9. Default Risk: If an employee with a loan leaves their job or is terminated, the full loan balance typically becomes due within a short period. If they cannot repay it, the loan may default, and the unpaid balance will be taxed as a distribution.
  10. Spousal Rights: In plans subject to the Employee Retirement Income Security Act (ERISA), the spouse of the participant may need to consent to the loan if the loan amount exceeds a certain threshold.

It’s important for individuals to carefully consider the pros and cons of taking out a 401(k) loan and to consult with a financial advisor or their plan administrator.