How do 401(k) loans work?

By Chizoba Morah AAA
A:

When individuals are in a tight spot financially, they usually turn to 401(k) loans. The interest rate for the 401(k) loans are usually a point or two higher than the prime rate, but they can vary. By law, individuals are allowed to borrow the lesser of $50,000, or 50% of the total amount of the 401(k).

Like any other loan, there are pros and cons involved in taking out a 401(k) loan. Some of the advantages include convenience and the recipient of the interest paid. For example, if you take out a 401(k) loan and you are paying 12% interest on it, that 12% is going back to your 401(k) because that is where the money is from. One major disadvantage of a 401(k) loan is the loss of tax sheltered status in the event of a job loss. If you take out a loan on a 401(k) and you lose a job or change jobs before the loan is fully repaid, there is a 90 day period in which the full amount of the loan is to be repaid. If the loan is not fully repaid at the end of the 90 days, not only does the amount become taxable, an additional 10% penalty is charged by the Internal Revenue Service (IRS) if you are under the age of 59.5. (For more on 401(k) plans, read our article: The 4-1-1 on 401(k)s.)

This question was answered by Chizoba Morah

RELATED FAQS

  1. Are qualified retirement plans protected from creditors?

    Learn how to protect your retirement assets from creditors. Certain provisions provide for exemption of retirement assets ...
  2. Can savings from a Roth 401(k) be used for college without penalty?

    Understand how a Roth 401k retirement savings account can be used to pay for tuition, what criteria must be met, and the ...
  3. What are the benefits of an independent/individual 401(k)?

    Understand the benefits of the individual 401(k) retirement savings plan and how it differs from traditional IRA based retirement ...
  4. How does a defined benefit pension plan differ from a defined contribution plan?

    Learn the differences between defined benefit plans and defined contribution plans when reviewing employer-sponsored qualified ...
RELATED TERMS
  1. Self Invested Personal Pension (SIPP)

    A tax-efficient retirement savings account available in Great ...
  2. Senior Move Manager

    Senior move managers (SMMs) help seniors downsize and relocate ...
  3. Elder Care

    Elder care, sometimes called elderly care, refers to services ...
  4. Eligible Transfer

    An IRS-allowed movement of assets into or out of an individual ...
  5. Death Master File (DMF)

    Also known as Social Security Death Index. A list of people whose ...
  6. Leveraged Benefits

    The use – by a business owner or professional practitioner – ...

You May Also Like

Related Articles
  1. Personal Finance

    Are qualified retirement plans protected ...

  2. Retirement

    Can savings from a Roth 401(k) be used ...

  3. Retirement

    What are the benefits of an independent/individual ...

  4. Professionals

    Who Wants to be a 401(k) Millionaire?

  5. Professionals

    Are Longevity Annuities in 401(k)s a ...

Trading Center