Your Money: What to know before borrowing from your 401(k)

HUNTSVILLE, Ala. (WAFF) – Borrowing from a 401(k) is a unique financial tool where you function as both the borrower and the lender, but not all workplace plans allow it.

Financial expert Marshall Clay from The Welch Group said the first step is confirming eligibility.

“Typically, you see it everywhere in terms of big, huge corporations,” Clay said. ”But if you work for a smaller business, a lot of times they don’t offer this.”

Borrowing limits and vested balance rules

Clay said borrowers can only access their vested balance, which includes money they contributed themselves but may exclude employer contributions that have not yet vested.

The borrowing limit is the lesser of $50,000 or 50% of the vested balance, with one exception.

“There’s a flat $10,000 that you can typically borrow,” Clay said. “So, say that you had $10,000, you don’t fall into that 50% rule where you could only borrow five.”

Application and interest rates

Most companies that offer 401(k) loans allow online applications with no credit check or justification required. Spousal consent may be needed, and funds are typically received via direct deposit.

The interest rate is typically the prime rate plus one, currently around 7.75%. But borrowers pay that interest back to themselves.

Repayment terms

Repayment plans typically span five years, with payments automatically deducted from paychecks after tax.

“You’re borrowing money from your 401k because you’re probably in a little bit of a dire financial need, but you have to understand that when these repayments start, you’re not going to get as much money deposited in your checking account on a month-over-month basis,” Clay said.

Clay recommended understanding all available financial options before a crisis occurs, including home equity lines of credit.

“Life has a way of throwing us all curveballs and having that extra optionality is very important,” Clay said.

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