On top of that, if you decide to reduce or stop contributions to your k account as you repay your loan, you could miss out on any returns on those contributions. You may be able to access your money within a week. If you miss loan payments and your loan goes into default , it can be treated as a retirement plan distribution. It could get even more expensive from there.
Any unpaid loan amount means fewer dollars in your k. To avoid paying tax at the time of distribution, you could roll over your loan balance into an eligible retirement plan by the federal income tax filing date including extensions for that year. Depending on your financial situation, a k loan could be a good option for accessing money to pay off high-interest debt or to cover a big expense.
But in other cases, this type of loan could end up costing you, so it might not be the right choice. Before you take out a k loan, consider possible alternatives, like a home equity loan or personal loan. While we strive to provide a wide range offers, Bankrate does not include information about every financial or credit product or service.
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The information on this site does not modify any insurance policy terms in any way. A k is an employer-sponsored retirement savings plan that lets you set aside pre-tax dollars or after-tax dollars if you have a Roth k from your paycheck to help fund your years after you stop working. According to IRS rules, you have five years to pay back the loan, unless the funds are used to buy your main home, in which case you have more time to repay. A k loan has some key disadvantages, however.
And the less money in your plan, the less money that grows over time. Even when you pay the money back, it has less time to fully grow. You may not get one. Having the option to get a k loan depends on your employer and the plan they have set up.
A study from retirement data firm BrightScope and the Investment Company Institute says that 78 percent of plans gave participants the option to borrow based on data. So you may need to seek funds elsewhere.
You have limits. You might not be able to access as much cash as you need. You could pay taxes and penalties on it. Under the new tax law, k borrowers have until the due date of their federal income tax return to repay in such circumstances. The old rule called for repayment within 60 days. A loan allows you to avoid paying the taxes and penalties that come with taking an early withdrawal.
Additionally, the interest you pay on the loan will go back into your retirement account, although on a post-tax basis. One alternative to a k loan is a hardship distribution as part of an early withdrawal , but that comes with all kinds of taxes and penalties.
A hardship distribution through an early withdrawal covers a few different circumstances, including:. Keep in mind, however, that this will proportionally reduce your personal non-retirement savings.
The above discussion leads us to address another erroneous argument regarding k loans: By withdrawing funds, you'll drastically impede the performance of your portfolio and the building up of your retirement nest egg. That's not necessarily true. First of all, as noted above, you do repay the funds, and you start doing so fairly soon. Given the long-term horizon of most k s, it's a pretty small and financially irrelevant interval. The percentage of k participants with outstanding plan loans in latest information , according to a study by the Employee Benefit Research Institute.
The other problem with the bad-impact-on-investments reasoning: It tends to assume the same rate of return over the years and—as recent events have made stunningly clear—the stock market doesn't work like that. A growth-oriented portfolio that's weighted toward equities will have ups and downs, especially in the short term.
If your k is invested in stocks, the real impact of short-term loans on your retirement progress will depend on the current market environment. The impact should be modestly negative in strong up markets, and it can be neutral, or even positive, in sideways or down markets. The grim but good news: the best time to take a loan is when you feel the stock market is vulnerable or weakening, such as during recessions.
Coincidentally, many people find that they need funds or to stay liquid during such periods. There are two other common arguments against k loans: The loans are not tax-efficient and they create enormous headaches when participants can't pay them off before leaving work or retiring.
Let's confront these myths with facts:. The claim is that k loans are tax-inefficient because they must be repaid with after-tax dollars, subjecting loan repayment to double taxation.
Only the interest portion of the repayment is subject to such treatment. The media usually fail to note that the cost of double taxation on loan interest is often fairly small, compared with the cost of alternative ways to tap short-term liquidity. She anticipates that she can repay this money from her salary in about a year.
Here are three ways she can tap the cash:. Double taxation of k loan interest becomes a meaningful cost only when large amounts are borrowed and then repaid over multi-year periods. Suppose you take a plan loan and then lose your job. You will have to repay the loan in full. While this scenario is an accurate description of tax law, it doesn't always reflect reality.
At retirement or separation from employment, many people often choose to take part of their k money as a taxable distribution, especially if they are cash-strapped. Having an unpaid loan balance has similar tax consequences to making this choice. Most plans do not require plan distributions at retirement or separation from service. People who want to avoid negative tax consequences can tap other sources to repay their k loans before taking a distribution. If they do so, the full plan balance can qualify for a tax-advantaged transfer or rollover.
The more serious problem is to take k loans while working without having the intent or ability to repay them on schedule. In this case, the unpaid loan balance is treated similarly to a hardship withdrawal , with negative tax consequences and perhaps also an unfavorable impact on plan participation rights.
Regulations require k plan loans to be repaid on an amortizing basis that is, with a fixed repayment schedule in regular installments over not more than five years unless the loan is used to purchase a primary residence.
Longer payback periods are allowed for these particular loans. The IRS doesn't specify how long, though, so it's something to work out with your plan administrator. Borrowing from a k to completely finance a residential purchase may not be as attractive as taking out a mortgage loan.
Plan loans do not offer tax deductions for interest payments, as do most types of mortgages. And, while withdrawing and repaying within five years is fine in the usual scheme of k things, the impact on your retirement progress for a loan that has to be paid back over many years can be significant. However, a k loan might work well if you need immediate funds to cover the down payment or closing costs for a home.
It won't affect your qualifying for a mortgage, either. Since the k loan isn't technically a debt—you're withdrawing your own money, after all—it has no effect on your debt-to-income ratio or on your credit score, two big factors that influence lenders.
If you do need a sizable sum to purchase a house and want to use k funds, you might consider a hardship withdrawal instead of, or in addition to, the loan.
United Kingdom. Miranda Marquit, John Schmidt. Contributor, Editor. Editorial Note: Forbes Advisor may earn a commission on sales made from partner links on this page, but that doesn't affect our editors' opinions or evaluations.
What Is a k Loan? Learn About the Terms While the government sets limits on borrowing and other items, plan administrators can determine their own requirements within those.
Fill out the Required Paperwork Depending on the plan administrator, you may be able to complete this step online. Receive the Loan Depending on your employer and k plan administrator, you may receive the funds directly in your bank account or as a check. Make Regular Payments on the Loan You may have to make monthly or quarterly payments, depending on your plan.
Should You Get a k Loan? Was this article helpful? Share your feedback. Send feedback to the editorial team. Rate this Article. Thank You for your feedback! Something went wrong. Please try again later. Recommended Reading. What Is A k Rollover? What Is an Employer's k Match?
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