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4 essential things to know before applying for a 401(k) loan

4 essential things to know before applying for a 401(k) loan

There’s no preordained age when one has to start saving for their retirement. However, the cardinal rule when it comes to leading a comfortable retirement is that the sooner you start, the better. It has become easier to save for retirement as employers offer several retirement plans to their employees. Among these retirement plans, the 401(k) plan is extremely popular. This plan allows employees to save and invest a determined amount from their paycheck even before the taxes are deducted. Though there are restrictions on the amount of money you can contribute to this retirement plan, 401 (k) is an ideal choice if you wish to lead a comfortable life as a retiree.

Another reason the 401(k) plan is popular among employees is that it allows them to borrow money from the funds in case of a financial emergency. Though the working population stands divided where 401(k) loans are concerned, it might be your only way out of a financial turmoil. Before you decide to apply for a 401(k) loan, there are certain factors you should know about such loans. They are as follows:

  • The 401(k) is subject to legal loan limits: Though the 401(k) plan is constituted with your saved money, you cannot borrow all of it. There is a maximum loan amount set by law and you have to adhere to it. The law asserts that the maximum amount of money you can borrow in the form of 401(k) loan will be $50,000 or 50 percent of your vested account balance, whichever is less. This vested account balance is the amount of money that belongs to you, and this also implies that you will have to stay with your employer for a set amount of time before the employer contribution can be attributed to you.
  • The loan will be paid up through payroll deductions: Unlike the other loans offered by banks which have a tenure of 10 or 20 years, the 401(k) loans have to be paid within 5 years. Moreover, the 401(k) loan repayments are usually directly deducted from your paycheck. Also, most repayment plans are structured to accommodate monthly or quarterly payments. Another important factor pertaining to repaying the 401(k) loan is that some of these plans won’t permit you to make a contribution while you are repaying the loan. Moreover, if you lose or quit your job before repaying the entire loan, you will have to repay the balance quickly, or you will be at risk of being categorized as an early distribution.
  • Not all 401(k) plans allow loans: Before you decide to opt for a 401(k) loan, it is essential that you check with your 401(k) plan administrator or investment company whether they allow you to borrow from your savings. Not all 401(k) plans allow a withdrawal in the form of a 401(k) loan. In such cases, it is imperative that you have a back-up plan instead of solely relying on your 401(k) loan.
  • Late repayment can be a costly affair: When you receive a 401(k) loan, you do not have to pay taxes on the amount you received. However, if you fail to repay the loan on time, the taxes and penalties would start piling up. Moreover, if you quit your job with an outstanding 401(k) loan, the remaining balance would be considered as distribution right away, unless you repay it.

So, ensure that you are apprised of all the possible scenarios before applying for a 401(k) loan.