How do I repay my 401k loan?

If your employer allows 401(k) loans, you can tap into your accumulated savings to borrow up to $50,000. As long as you have a sufficient balance, you can be allowed to borrow from your 401(k) and pay back the loan over time. While most employers require automatic loan payments through payroll deductions, some plans may rest this responsibility on employees, and you have to figure out how to pay the loan on time.

Most 401(k) plans require employees to make automatic loan payments from their paycheck through payroll deductions. If you opt out of automatic loan payments, you should create a structured plan on how you are going to pay the loan. You can also make extra payments or a lump sum payment to pay the 401(k) loan early. If you have an unpaid loan in the former employer’s plan, you can take a new 401(k) loan with the new employer to pay the old 401(k) loan.

7 Ways on How to Repay 401(k) Loan

If you recently took a 401(k) loan, there are certain things you can do to avoid taxes and penalties on the loan:

Pay loan from your paycheck

If you have a 401(k) loan with your employer, you may be required to pay back the loan from your paycheck. Usually, the employer will automatically deduct loan payments directly from your salary before the money gets to you. This is the easiest way to pay the loan because you won't have to do anything when the loan is due.

However, if you have an unpaid loan with a former employer, you must make payments when the loan is due. You can make periodic payments via check, or choose to make a lump-sum payment to clear the loan before the tax due date to avoid triggering taxes and a potential penalty.

Create a structured repayment plan

If the loan payments are not automatically deducted from your paycheck, you should create a plan on how you are going to repay the loan. Start by examining your monthly budget to determine how much is left after paying other debts and household expenses. Then, decide how much you can comfortably pay each repayment period.

If you have a tight budget, and you cannot afford the expected periodic payments, it doesn't hurt to start a conversation with the employer on how you are going to pay back the loan. If the expected loan payments exceed your monthly budget, you can agree to a quarterly payment. You can then deposit the loan payments into a savings account so that you can accumulate enough money for the quarterly payments.

Pay the 401(k) loan early

One of the attractive features of 401(k) loans is that you won’t be charged a prepayment penalty when you make extra payments. You can choose to pay more every month or quarter so that you can pay off the outstanding loan balance early. For example, if you are paying $500 every month, and you have money left in your budget, you can double this amount to $1000 every month until you pay off the loan.

You can also round off payments to the nearest figure to reduce the repayment period. For example, if you are paying $528 every month, you can round off this payment to $600. The additional $72 payment will amount to $864, which can reduce the repayment period by one month every year.

Make a lump sum payment

If you receive a windfall or a large payment, you can use part of the money to settle the loan in one lump sum payment. You will need to calculate how much loan is unpaid, including any interest payments, and settle any outstanding obligations. You won’t owe any prepayment penalties for paying off the loan early.

Take a new 401(k) loan with the new employer

If you left your employer and you had an outstanding loan- and you are unable to keep up with the loan payments, you can take a new loan with your new employer to pay off the old loan. In this case, you could take a 401(k) loan that is equivalent to the outstanding balance of the old 401(k) loan. The new employer will deduct loans payments automatically from your paycheck.

Take a distribution

If you are unable to keep up with the loan payments, you can decide to withdraw funds from your 401(k) to pay off the loan. You must have built an adequate balance in your 401(k) for the withdrawal to be approved. A 401(k) withdrawal is permanent, and you won’t be required to pay back the money. Hence, once you use the funds to pay off the unpaid loan, you won’t have further obligations. However, if you are below age 59 ½, you will be required to pay taxes and penalties on the amount withdrawn.

Pay off the loan before leaving your job

If you plan to leave the company, and you have an active 401(k) loan, you should work out a plan to pay the loan balance before you leave. You can increase the loan payments or offer to clear the loan with a lump sum payment before you leave. Usually, leaving a job with an unpaid loan means you will have to pay back the full loan amount within a shorter period, usually before the tax due date for federal tax returns. If you don’t pay the balance in full before the tax deadline, the unpaid loan could be considered a taxable distribution, and you could pay taxes and penalties on the distribution amount.