How Do You Borrow From Your 401k Plan Without Incurring a Big Penalty?


Quick Answer

There is no penalty for borrowing against a 401K account, according to Forbes. However, if the loan is not paid back in five years, or 60 to 90 days if employment ceases, then early withdrawal penalties are applied.

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How Do You Borrow From Your 401k Plan Without Incurring a Big Penalty?
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Full Answer

Approximately 87 percent of companies allow 401K loans, states Forbes. Most plans allow for loans up to 50 percent of the vested account balance with a $50,000 maximum. Interest is applied to the loan at a rate of one to two points above the prime rate. Fortunately, the interest is paid back to the employee's account where it is reinvested. In addition, the rate is typically much lower than standard bank loans.

Because no credit check is required, most 401K loans are easy to obtain. Repayment of the loan is effortless to manage as most employers allow for automatic deductions from the employee's pay check. Although the process sounds appealing, Forbes warns that 401K loans do have consequences. Interest is not tax deductible, like most loans, and the borrowed amount is not earning anything until paid back to the account.

If the loan is not paid back, and the borrower is younger than 59.5 years, a 10 percent penalty and income tax is applied to the loan, states CBS Money Watch. Loan defaults typically occur because an employee quit or loses his job. Therefore, when borrowing against a 401K account, an employee should consider other loan options before dipping into retirement funds. After all, the purpose of a 401K plan is to provide for the future and not today.

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