How much can you borrow from your 401k?

When you need cash to pay for college or pay down payment for your home, you should consider taking a 401(k) loan. Usually, most retirement savers tap into their retirement savings to meet short-term liquidity needs since it is a quick and low-cost option to get the cash you need.

If your retirement plan allows 401(k) loans, you can borrow the greater of $10,000 or 50% of the vested plan balance up to a maximum of $50,000. For example, if your 401(k) balance is $50,000, you can borrow up to $25,000. When you take a 401(k) loan, you must pay back the principal amount plus interest within 5 years from the time you took the loan. 

Should You Borrow from 401(k)?

Borrowing from your 401(k) account can be beneficial in some ways. For example, you can take a 401(k) loan to pay for home improvements such as roof repair, painting, or fixture and fittings replacement, which could raise the value of your property. This can help you add a few thousand dollars to the property valuation if you decide to sell it.

You can also take a 401(k) loan to pay another high-interest debt to reduce the amount of interest you owe the lender. In this case, the 401(k) loan would help you avoid additional interest and penalty costs.

On the flip side, a 401(k) loan might be a bad idea if you are using the funds to buy gifts, pay entertainment expenses, or other unnecessary expenses. It would be better to keep the retirement money in a retirement account, and pay these expenses out-of-pocket or using other sources of cash.

Using 401(k) Loan to Buy a Home

If you are cash-strained and you are looking for ways to fund the purchase of your house, taking a 401(k) loan can help you pay these costs. Usually, IRS rules require participants to pay 401(k) loans on an amortizing basis for not more than five years. However, if you plan to use the 401(k) loan to buy a primary residence, you may be allowed a longer repayment period. The repayment terms are determined by the plan administrator, and you could be allowed to repay the money for a longer period than the prescribed 5 years.

You can borrow up to $50,000 to pay the down payment for your primary residence or the closing costs. The loan will not appear on your credit report, and it will not have any impact on your credit score or debt-to-income ratio, since you are borrowing your own money. However, taking a 401(k) loan to completely finance the purchase of a house may not be feasible compared to using a mortgage loan. 401(k) loans do not allow tax deductions for interest payments, and you would be better off with a mortgage loan to get tax deductions and lower your tax bill. Also, taking a larger loan could affect the future potential for growth since the loan will be paid over many years.

401(k) Loan vs 401(k) Withdrawals

If you are looking to raise money quickly (with no other sources available), you can opt to borrow or withdraw from a 401(k) account. Here is how these two options compare:

401(k) Loan

A 401(k) loan allows plan participants to borrow against their retirement savings, and pay back the loan over time. The interest you pay on a 401(k) loan goes back to your retirement savings and it will help grow your savings further.

You can borrow up to $50,000 if you have $100,000 or more in your 401(k) balance, and you can use the funds to pay for college, medical expenses, and down payment for your primary residence. You should check with your 401(k) plan administrator to know if the employer’s plan rules allow 401(k) loans and how much you qualify to get.

401(k) Withdrawal

If you have an immediate financial need, you can request a hardship withdrawal from your 401(k) account. The plan administrator will approve only the amount needed to cover the financial hardship. Unlike a 401(k) loan, a withdrawal does not require you to pay back the amount you withdraw, but you will owe taxes and potentially an early withdrawal penalty on the amount you take out.

To qualify for a 401(k) withdrawal, the 401(k) plan must offer this option, and you must prove that you are facing an “immediate financial need.” For example, the situation could be an imminent foreclosure, medical expenses, repairing damage to the primary residence, medical or funeral expenses of a family member, etc. If you are 59 ½ or older, you won’t be charged a penalty tax for early withdrawals. A 401(k) withdrawal allows participants to withdraw more than the $50,000 limit imposed on 401(k) loans.

Reasons to Borrow from 401(k)

Here are some reasons why you should consider borrowing from a 401(k):

Payment Flexibility

A 401(k) loan allows participants greater flexibility in loan repayment compared to when using a bank loan. If your 401(k) loan has a term of 5 years, you can choose to repay the entire loan early without paying prepayment penalties. You can continue making the regular 401(k) contributions while repaying the loan using automatic payroll deductions.

Convenience

When you request a 401(k) loan from the plan administrator, you are not subjected to credit checks to determine your creditworthiness. Also, the plan administrator does not make credit inquiries to credit bureaus, which could appear on your credit report. You can request a 401(k) loan either through the 401(k) plan website or by contacting the plan administrator via email or phone.

Grow retirement savings

When repaying a 401(k) loan, the principal and interest payments go back to the 401(k) account. The interest paid is allocated into your portfolio of investments, and it will earn additional returns over time. If the interest you earn is higher than the value of lost investment earnings, this will increase your retirement savings.