How to Get a Loan from Your 401k Plan

You can take a penalty free loan from your 401k in certain circumstances. Before considering a loan, consider taking a one-time withdrawal for a qualified expense. You can avoid both penalties and interest if your expense qualifies. Beyond this regulation, you may be able to borrow money from the account according to IRS rules. Whether you can borrow the money depends on your company's policy and the purpose of your debt.

Qualified Expenses

You can make a one-time withdrawal from a 401k to pay for qualified higher education expenses for yourself or a dependent. You can also take the funds out to pay for the down payment on your first home so long as it is a primary residence. In both of these scenarios, you will owe taxes on the withdrawal if you have a traditional 401k. However, you can avoid the additional 10 percent penalty you would typically incur for an early withdrawal. These are the only scenarios when you can outright take money out of the account without facing a penalty. Otherwise, you will need to retire or reach age 59-1/2 before taking money out of the account. If this is not an option, you will need to pursue a loan option.

Company 401k Loan Regulation

Corporations offer 401k accounts to their employees. An individual investor cannot open a 401k account; individuals can open only individual retirement arrangements (IRAs). If you are the owner of or the employee of a company with a 401k, you can pursue a loan from the account. Company policy dictates whether this is permissible. Some employers will not permit access to the account for a loan. You may still withdraw from the account, since you do personally own the funds, but you will be forced to pay the early withdrawal fee of 10 percent. If your company does permit a loan, you will still be subject to the laws of the IRS.

IRS 401k Loan Regulation

When you take a 401k loan, you must replace the funds within a limited period. Regulation 72(p) of the IRS code dictates that the loan be repaid in no more than five years. During this time, you will have to pay regular interest on the debt and make regular payments. You must make these payments, including interest, to your employer. The employer can set more restrictive regulation, but this is the minimum required by the corporation. The loan cannot be used to purchase an income-producing investment. If this occurred, an individual could use pre-tax dollars to purchase investments and earn income, which is not permitted under qualified retirement plan regulation. 

401k Loan Warnings

Whenever you borrow from your retirement plan, you may compromise the account you have worked hard to build for your future. While your funds are out on loan instead of in the 401k account, they are not earning any income for your retirement. Most financial advisers do not recommend 401k loans unless you have no other options. For example, the loans are often used to pay medical emergency expenses. They should not be used to pay for vacations or luxury purchases. 

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