Generally, you may be able to borrow money from your 401(k) plan account if your employer's plan offers loans. Additionally, due to the CARES Act, you may be able to take a tax-favored distribution from your 401(k) account with the option to repay it later on if you are a qualified individual affected by the coronavirus (if your employer's plan allows). Learn more about the
CARES Act implications for retirement plans and accounts.
Many 401(k) plans allow you to borrow up to 50% of your vested account balance, up to a maximum of $50,000, before you retire. Because rules vary from plan to plan, you should check with your plan administrator to be sure. But it might not be a good financial move.
Pros and cons of borrowing from your 401(k) account
Weigh your options carefully before taking out a loan from your 401(k) account.
Pros
- Immediate funds to meet short-term liquidity needs
- Pay interest to yourself rather than to another lender
Cons
- Loss of tax-deferred growth potential on borrowed funds
- Repayments are made with interest
- Some plans don't allow contributions while repaying the loan
- Possible federal income tax and additional 10% federal tax on early withdrawals on the outstanding balance if you switch employers before paying back the loan and do not roll over the balance
- Possible additional 10% federal tax on early withdrawals if you don't pay back the loan and were under age 59½ at the time you defaulted on the loan unless you qualify for an exception
If you need money for a large, immediate expense — and you don't have access to other funds — sometimes it makes sense to take out a 401(k) loan. But, keep in mind that borrowing from your 401(k) account might be costly in several ways:
- The money you borrow will no longer earn potential tax-deferred growth within the account, and you could potentially miss out on significant profit.
- You'll not only have to repay the loan, but also pay interest.
- Paying off the loan may mean you're unable to contribute as much to your retirement account as you normally would.
- In rare instances, some 401(k) plans won't let you make contributions until the loan is repaid.
Because the money you borrow will no longer earn potential tax-deferred growth, you could potentially miss out on significant profit.
It's important to understand the possible effects an early withdrawal could have on your retirement account and your overall finances. As with any financial decision, it's important to educate yourself on the pros and cons of each option before making a choice.
Do I have to pay taxes on a 401(k) loan?
If you leave your employer before the loan is paid off, you may owe federal and state income taxes on the distribution — on top of a 10% additional federal tax if you're under age 59½ — unless an exception applies. You generally have until your tax filing deadline (including extensions) for the year in which the loan was treated as a distribution to make a rollover to an eligible retirement plan (equal to the amount of the distribution) to avoid being taxed. Consult your tax advisor if you’re considering this option.
How do hardship withdrawals work?
If your employer's plan allows, you can apply for a hardship withdrawal if, for instance, you're facing eviction or need to pay for certain medical expenses. Your withdrawal typically will be treated as taxable income. Another consideration: A hardship withdrawal permanently reduces your retirement account balance and gives you no option to repay, which can make it difficult to get back on track with your retirement savings goals.