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401k Loan Rules Steps To Getting 401(k) Loans

Updated on March 12, 2012

Loan Against 401k Steps

When it comes to investing for retirement, few strategies are more commonly used than investing part of your paycheck into a 401(k) plan. 401k plans provide a way to lower taxes because contributions are made using pre-tax dollars. All of the gains, the dividends, and interest from inside of a 401(k) grows tax-deferred. A similar account is the 529 plan for saving for college.

Unfortunately, all of these advantages comes with a string attached. Money inside of a 401(k) is not usable without penalty until after the owner turns 59 1/2 years of age. Most companies do not even allow withdrawals from their 401k plans while someone is an employee. The good news is that there is an option to get a loan from your 401k plan, but taking out a 401k loan isn't always easy.

How To Get 401k Loan

The big catch to 401k loans is that most companies require that the loan be repaid very quickly if the employee leaves the company. Repaying a large loan right away can be very tough and could trap you in your job for longer than you intended.

Once you understand the implications of getting a 401k loan, review your company's plan document to make sure that loans are even offered with your 401(k) plan. Although 401k loans are allowed by the IRS, there is no requirement that they be offered. The plan document is an official binding document that governs the company's 401k. It spells out whether loans are available.

Once you know that loans are offered, you'll need to get the forms to apply for a 401(k) loan. Loans from 401(k)s must be applied for like regular loans. However, no credit check will be needed since you are borrowing your own money. Usually, applications can be obtained from Human Resources. Applications might also be available on the company website, or the plan administrator company website.

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Next, fill in the loan application. Pay attention to the options offered by the plan. Common variations are: amount of the loan, term of the loan, and monthly payment. Once completed, send in the application. Often the application will need to be sent to a third-party and not necessarily where the application was obtained from in the first place. Keep a copy of the application for your records.

401k plan loans require a promissory note that details the terms of the loan. Terms include interest rate, repayment schedule, monthly payment, and term. Note that when given the option of choosing the length of repayment, always choose the longest option. Selecting the longest option will create the lowest required monthly payment. Other payments can always be made manually to pay the loan off quicker, but terms cannot be changed after issue which means that you will be stuck with the minimum payment.

You can use 401k loan money for any purpose. It does not need to be used for specific purposes like education or buying a house. Keep in mind that the money lent out will not grow in value while being repaid because it is not invested in anything.


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    • Pearldiver profile image

      Rob Welsh 7 years ago from Tomorrow - In Words & NZ Time.

      Thanks for sharing this concise breakdown. Well written and has been easy to understand. I guess many people were negatively effected exposure-wise in the recent meltdown? Take Care.