Employees who have been consistently making contributions to their workplace retirement plans have probably accumulated a sizable nest egg.
At the end of the second quarter of 2019, Fidelity Investments’ average 401(k) balance was $106,000.
Several diligent savers have even reached seven figures: 196,000 Fidelity clients had at least $1 million stashed away in their 401(k)s.
The best course of action is to let your savings grow at a market rate throughout your working years.
However, even those who are well-prepared occasionally experience disasters that may necessitate taking out a plan loan.
According to Rockie Zeigler, a certified financial planner and the owner of RP Zeigler Investment Services in Peoria, Illinois, “one person who needed a new roof was able to get a better rate on a 401(k) loan than he could through the roofing company.”
“They usually tell me after the fact, but I’ve never had someone come and ask me about taking a loan,” he said.
3 ways to tap your savingsA couple works on home renovations.HeroImages | Getty Images
Different rules apply to withdrawals, loans and hardship distributions.
Loans. If your employer allows you to borrow from your 401(k), you may be able to take out a loan free of taxes — if you meet certain criteria.
However, you are only permitted to withdraw a maximum of $50,000 or 50% of your vested account balance.
You have five years to pay back the loan, and you must make at least quarterly payments that are substantially level.
Withdrawals. 20% of your 401(k) plan distributions are withheld for taxes. If you are under 5912, there is also a 10% penalty.
Hardship distribution. Your plan might allow you to take a hardship distribution. The IRS allows this if its made due to an “immediate and heavy financial need.”
Medical care, funeral costs, and payments required to keep that employee from being evicted from her home are examples of acceptable emergencies.
These distributions are not returned to the plan; instead, they are included in your gross income and may be subject to additional taxes.
Therefore, taking a hardship distribution results in a permanent decrease in your balance.
3 times when you can borrowGetty Images
Whether it was withdrawn or borrowed, money that was taken out of your plan is no longer earning compound interest and market growth.
In a pinch, you should turn to your emergency fund first. If you own a home, a home equity line of credit might be the next-best option.
Here are three scenarios that could necessitate a 401(k) loan if both fail.
An urgent matter: Perhaps the threshold for your employer’s high-deductible health plan is so high that you lack the funds in your health savings account to cover it, according to Aaron Pottichen, senior vice president of Alliant Retirement Consulting in Austin.
He is speaking of the tax-advantaged health savings account that individuals can use to pay for eligible medical costs.
A financial emergency during a time of poor credit: You may require immediate cash but lack the credit score necessary to obtain a personal loan at a reasonable rate.
However, don’t take this action without taking into account your ability to pay back the plan loan in five years.
Your long-term goals are being hampered by expensive high-interest debt, say your 401(k) loan’s interest rate is lower than the rate your creditor is currently offering you.
What’s your cheapest interest rate and how quickly can you pay off the debt? are the two main considerations if you’re in debt repayment mode, according to Pottichen.
3 rules to followMoyo Studio | E+ | Getty Images
If you borrow money from your 401(k) and break any of these three rules, you’ll find yourself in even worse financial straits.
Planning on leaving? Rethink borrowing. Prior to the Tax Cuts and Jobs Act, employees had 60 days to repay the loan if they lost their job or were laid off.
Thanks to the tax reform, you now have a little more time to make the payment.
If you leave your job with an unpaid loan, you may have until the due date of your federal income tax return, including extensions, to roll over the amount owed to an IRA or another 401(k) plan.
Youre still on the hook to pay what you owe. The remaining amount could be viewed as a taxable distribution if you don’t pay it back.
According to Zeigler, “Whatever loan balance is left must be paid off with your own money or it comes out of your 401(k) balance and is taxable.” “Its a pitfall. “.
Borrow responsibly. The last thing you want to do if your finances are already bad is take on more debt. The 401(k) loan should be handled similarly to any other form of credit.
Make sure that servicing debt, which includes mortgage payments, credit card payments, and student loan repayments, takes up no more than 36% of your gross monthly income.
Dont blow off your plans rules. Your retirement plan will establish the conditions under which you are permitted to obtain a loan, including the application process and the terms of repayment.
Additionally, the plan specifies how your employer would respond in the event of a default, which is typically a taxable distribution. Understand the rules and stick to them.
FAQ
Does your employer know if you take a loan?
Lenders may get in touch with your employer if you apply for a personal loan. To verify your employment status or to check on a repayment, a lender might call. However, the lender will only contact you, and neither your employer nor the call’s purpose will be disclosed to them.
Does my employer have to approve my 401k loan?
The 401(k) plan administrator is responsible for approving 401(k) loans. The plan administrator must review your loan application after you submit it to determine whether you are eligible to borrow from your retirement savings.
Does a 401k loan show up?
Answer: No, a 401k loan won’t show up on your credit report. Although 401(k) loans are not reported to credit reporting agencies, lenders may inquire about them if you apply for a mortgage, in which case they will count the loan as debt.
Can I be denied a loan from my 401k?
Your request for a 401(k) loan could be rejected by a plan for a number of reasons. Due to the possibility of your job being eliminated during a restructuring process, your impending retirement, or the fact that you have borrowed more money than allowed, your 401(k) loan may be rejected. If your 401(k) loan was rejected, you need to learn the reasons why.