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What are some rules for 401(k) loans?

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Quick Answer

Employees can borrow at least $10,000 and a maximum of the lesser of half of the vested account balance or $50,000 from a 401(k) plan that allows loans, states the Internal Revenue Service. The loan must be repaid within five years unless an exception is allowed.

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Full Answer

Due to the fact that employees are essentially borrowing money from themselves using a 401(k) loan, there is no credit check, and application fees are generally low, notes About.com. The borrower must pay interest, and the interest goes back into the 401(k) account. Loan payments must be made quarterly in equal payments, explains the IRS. If an employee is purchasing a principal residence, he is allowed more than five years to pay back the loan. An employee in the military can suspend his loan payments.

When an employee leaves his employer, the 401(k) loan must be repaid, reports USA Today. If the loan is not repaid, it is classified as a distribution and is subject to a 10-percent penalty tax. Account holders must pay income tax twice because the loan repayment comes after tax dollars. This means the taxes are paid when repaying the loan and again when the funds are retrieved after the employee retires. Those who borrow from a 401(k) account lose out on investment growth until the funds are repaid, warns About.com.

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