How to Borrow from Your 401(k)

You can borrow from your 401(k) only if your plan document allows you to borrow for the specific reason you have in mind. Some 401(k) plans permit borrowing for any reason, but most permit loans only for certain specified reasons.

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To borrow from your 401(k)

• Get details about your particular account loans. Check out your summary plan description, or talk to your benefits office or 401(k) plan provider.

• Figure out how much you can borrow. The government sets the limits on how much you can borrow. Generally, you’re allowed to borrow no more than 50 percent of your account value up to $50,000 maximum. However, government rules theoretically permit borrowing 100 percent of an account up to $10,000. But most plans don’t allow this; they limit all loans to 50 percent of the account value for the sake of simplicity. Some plans also impose a minimum loan amount because administering a loan for only a few bucks isn’t worth the hassle.

• Determine how much interest you have to pay. The interest you pay on your 401(k) loan is determined by your employer and must be a level that meets IRS requirements. It’s usually the prime rate (the interest rate banks charge the most creditworthy companies) plus 1 or 2 percentage points. In most plans, the interest you pay goes back into your account, so you’re in the interesting position of being both the borrower and the lender.

• Find out the repayment period. You normally have to repay the loan within five years, but you can repay it faster if your plan permits. Your employer may permit a longer repayment period if you use the money for a home purchase.

• Ask about repayment methods. Employers usually require you to repay a loan through deductions from your paycheck. The loan repayments are taken out of your paycheck after taxes, not pre-tax like your original contributions. Then, when you eventually withdraw this money in retirement, you pay tax on it again.

This point bears repeating: You pay tax twice on money used to repay a 401(k) loan.