Can I Pay Back a 401(k) Loan in a Lump Sum?
401(k) loans must be repaid within five years. But can you pay back a 401(k) loan with a lump sum?
A 401(k) loan can be a great option to score a quick loan to pay for home repairs, car repairs, or to pay off some pesky debt. However, the parameters and tax implications should you default on the loan should be heavily considered. If you have the means to pay back your 401(k) loan early with a lump sum, should you do it?
You can certainly pay back your 401(k) loan in a lump sum if you have the funds to do so. If you’re looking to pay off your 401(k) loan sooner, a lump sum payment may be your only option. You’ll need to work with your 401(k)’s administrator on how to pay your 401(k) loan off with one lump-sum payment.
Most plans are equipped to deviate from the original amortization schedule laid out when the loan was drafted. Additionally, most 401(k) loans require payments to be made through automatic payroll deduction.
Pros of 401(k) loans
401(k) loans can certainly get you out of a financial pickle. Some of the pros of 401(k) loans include:
- No credit checks - you’re borrowing your own money, so your credit profile won’t be reviewed.
- Easy application - applying for a 401(k) loan is easy and can be done through your online portal or simply calling your plan’s administrator.
- You pay yourself back - rather than make interest payments to a bank, your interest payments on a 401(k) loan go back into your account.
- Long repayment schedule - the IRS requires 401(k) loans within five years. This gives you plenty of time to spread your payments out and keep your payments low.
Cons of 401(k) loans
While 401(k) loans have their benefits, they’re not perfect. 401(k) loans work well when everything goes according to plan. But deviate from the intended path, and you could end up in a worse position. Here are some of the cons to 401(k) loans.
- Fees - 401(k) loans come with fees that go to your 401(k) plan’s administrator. This is to facilitate the loan approval, funds disbursement, and your payment.
- Tied to your employer - if you quit your job or get fired, the entire balance may need to be repaid quickly, like within a few months in some cases.
- The IRS may get involved - if you default on your 401(k) loan and don’t pay, the IRS will deem the 401(k) loan an early retirement distribution. You’ll need to pay income tax and be hit with an additional 10% penalty tax.
- Payments are not tax-deferred - both the principal and interest payments are made with after-tax earnings.
Why would you want to pay your 401(k) loan off quickly?
Debt, whether a 401(k) loan or a loan through a bank, is relatively harmless until your financial situation changes. Having a goal to pay off debt faster is never a bad thing.
There are a few reasons why you would want to pay off your 401(k) loan faster:
- You’re planning on changing jobs soon - rather than waiting until after you leave your job and repaying your loan within a couple of months, planning ahead and saving the lump sum paying over time will help ease the burden.
- Avoid scrambling in the case you get fired or laid off - we like to think our jobs are secure. However, our employment is only as reliable as our employer deems it to be. Paying off your 401(k) loan early eliminates having to come up with the balance at a moment’s notice while trying to find a new job.
- Allow your retirement savings more time to grow - the more time your retirement savings aren’t in the market, the more time they aren’t earning compounding interest. Paying back your 401(k) loan early allows it more time to grow.
How to pay your 401(k) loan in a lump sum?
Most 401(k) plans don’t allow you to make additional payments on your 401(k) loan. Unable to facilitate changes to the amortization schedule that was set when the loan was created, many 401(k) plans only allow one lump sum payment to pay off a 401(k) loan early.
Unless you already have the lump sum amount saved up, you’ll need to save the amount over time in a separate account. Then when you have the entire amount saved up, you can send it over to your plan to pay off your outstanding 401(k) loan balance.
You’ll need to work with your 401(k) plan administrator on the best way to send the funds to your account. Some allow you to pay via an online portal; others may require a wire transfer or for you to send an actual check through the mail.
Make sure your old 401(k)s are still working for you in the meantime.
Rollover your old 401(k)s into your current account. You can monitor its investment performance and reallocate your funds to match your risk tolerance. This will help you better manage your retirement savings to ensure your meeting your retirement goals.