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Borrowing against retirement funds

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Most 401(k) loans must be repaid within five years, although you may be able to get a longer repayment term if you use the funds to buy a home.

Rules for borrowing from retirement funds

Before considering a 401(k) loan, find out if your plan even allows them. IRAs don't permit loans.2 However, some, but not all, employer-sponsored retirement plans allow them. Check with your 401(k) plan administrator to find out if loans are an option.

If they are, here are some other rules to keep in mind.

Your loan amount is limited

Typically, the maximum amount you can borrow from a retirement plan is 50% of your vested account balance, or $50,000,3 whichever is less. “Vested" balance means the portion of your account that your employer cannot take back if you leave your job. Your own contributions to the plan are always 100% vested,but many employers require you to work for a few years before fully owning your employer's matching contributions.

The CARES Act temporarily increased the maximum loan amount to 100% of the account balance, or $100,000,5 whichever is less. The increased loan limits are only available until Sept. 23, 2020.

You must repay the loan – or face tax consequences

Most 401(k) loans must be repaid within five years, although you may be eligible for an extended repayment schedule if you use the funds to buy a home.6

The CARES Act also allowed plans with outstanding 401(k) loans to delay payments due between Mar. 27, 2020, and Dec. 31, 2020 for one year. Interest continues to accrue during that time, so future loan payments will have to be adjusted to reflect the increased interest due.

As long as you repay the loan as agreed, it isn't taxable. However, if you leave your job while you have a loan outstanding, you have until the due date you file your tax return (including extensions) to repay it. Otherwise, it's treated as a taxable distribution, and you may have to pay income taxes and a 10% early withdrawal penalty7 on the loan balance.

How to borrow money from your retirement fund

If your retirement plan allows loans, getting one is usually fairly quick and easy. Many plans let you request a loan on your own via the website you use to handle other 401(k) tasks, such as changing your contribution amount. If you can't find the loan page on the site, contact your company's payroll department or fund administrator to ask how to apply.

If you're married, your plan may require you to get written consent from your spouse before they'll approve your application. You'll also need to sign a loan agreement that spells out the loan amount, term, interest rate, and any other applicable fees. Once you authorize the loan, the amount will usually be included in your next paycheck, or directly deposited into your checking account.

Things to consider when deciding to borrow from your retirement fund

Before you decide to take a loan from your retirement fund, here are some things to consider:

  • Do you have time to rebuild your savings before retirement? If you borrow from your retirement savings, there's a chance you won't be able to repay the loan in full. Plus, you could miss out on returns while the money isn't invested. So while borrowing from your account might solve your short-term financial troubles, it may leave you less secure in retirement.
  • Can you realistically repay the loan? Most 401(k) loans need to be repaid, with interest, within five years. Make sure you have a plan to pay back the loan within that time to avoid tax consequences.
  • Do you plan on staying at your job until the loan is repaid? If you leave your employment for any reason, you have a limited amount of time to repay the loan. Make sure you can realistically plan on staying with your employer that long.
  • Can you afford a reduction in your take-home pay? Most 401(k) loans require you to make payments via payroll deductions.This will reduce your take-home pay, which could make your financial troubles worse.
  • Will you miss out on matching contributions? Many plans do not allow participants to contribute to their retirement plan while they have a loan outstanding. If you're not able to contribute to your 401(k), you may also miss out on matching contributions from your employer.

The decision to borrow money from your retirement fund should not be made lightly. If you're unable to repay the amount you owe, having your loan treated like a taxable distribution can make a bad situation worse. For that reason, it's best to think of 401(k) loans as a last resort and only use them in a real financial emergency.

This content is general in nature and does not constitute legal, tax, accounting, financial or investment advice. You are encouraged to consult with competent legal, tax, accounting, financial or investment professionals based on your specific circumstances. We do not make any warranties as to accuracy or completeness of this information, do not endorse any third-party companies, products, or services described here, and take no liability for your use of this information.