There are a number of factors to weigh before taking a 401(k) loan or withdrawal from your current employer’s plan.
- Your plan must have a loan provision as part of its design for a loan to be available to you.
- Your plan could allow you to have more than one loan at a time.
Amount You Can Borrow
The minimum amount you can borrow is determined by your plan.
The maximum amount you can borrow is based on a formula set forth in regulations under the Internal Revenue Code. Your plan may impose a lower limit.
If you have not had a loan previously, the maximum you can borrow is 50% of your vested account balance or $50,000, whichever is less.
If you have had a loan previously, the maximum amount you can borrow is the lesser of:
- 50% of your vested account balance minus your current outstanding loan balance; or
- $50,000 minus your highest outstanding loan balance within the last 12 months.
Multiple Loan Example
Assume your vested account balance is $100,000, you took out a $30,000 loan eight months ago, and you still owe $10,000 on that loan.
If you want to take out a second loan, the most you can borrow is the lesser of:
- 50% of your $100,000 balance minus the $10,000 you still owe, or
- $50,000 - $10,000 = $40,000; or
- $50,000 minus your $30,000 highest loan balance in the last 12 months, or $50,000 - $30,000 = $20,000.
In this example, you may take out an additional loan up to $20,000.
Paying the Loan Back
Loans normally are paid back through payroll deduction.
Generally, you must pay the loan back over five years; a loan used to purchase a primary residence can have a longer payback period.
If you leave your company, in most cases the outstanding balance must be paid back by the filing date of your tax return for the year you separate from the service.
If you do not pay back your loan, any outstanding balance will be considered a distribution. Any pretax amount, both contributions and earnings, will be included in your income and may be subject to a 10% penalty if you are under age 59 1/2, with some exceptions.
Interest Rate & Fees
You pay interest on your loan back into your retirement account.
The interest rate you pay on your loan is often lower than other sources of borrowing. That interest rate may be less than what you would have otherwise earned on your money had it remained in your account.
Your plan may charge you a fee for processing the loan.
Your plan may require your spouse to approve your loan.
Some plans require you to wait a certain amount of time after paying off a loan before you can apply for another one.
Generally speaking, most 401(k) plans will not permit you to withdraw money while you are still an active employee. However, there are two kinds of withdrawals a plan may offer while you remain employed:
- Hardship: some plans allow you to withdraw money while still an active employee if you have an immediate and heavy financial need related to the following:
- medical expenses;
- education expenses;
- purchasing a primary residence;
- preventing foreclosure;
- repairing damage to primary residence; or
- funeral expenses.
Each item has additional details and requirements, and your plan may only allow some of these.
You can generally withdraw up to the total of what you have contributed to the plan, employer contributions, and investment earnings if your plan permits.
The maximum you can withdraw is the amount needed to meet the financial hardship, plus reasonably anticipated taxes and penalties on the withdrawal. A 10% penalty may apply if you make the withdrawal before you reach age 59 1/2.
Your plan may specify other requirements for you to receive a hardship withdrawal.
2. In-service: some plans allow you to withdraw money, while still an active employee, once you reach at least age 59 1/2.
For both hardship and in-service withdrawals:
- Your plan can specify the source(s) and order of money withdrawn (for example, pretax deferrals, Roth deferrals, and matching contributions, among others).
- Pretax amounts withdrawn from your account are considered taxable income.
- If you withdraw from your Roth account, and it is a nonqualified withdrawal, earnings are considered taxable and a 10% penalty may apply.
- Your plan can limit how often you may take a withdrawal.
- Your plan may require your spouse to approve your withdrawal.
3. Starting in 2020 the SECURE Act allows for penalty-free withdrawals to pay expenses related to the birth or adoption of a child. Parents with a new child may withdraw up to $5,000 without being subject to the 10% penalty on withdrawals prior to reaching age 59 1/2. The $5,000 amount is available to each parent (so $10,000 total for a married couple).
For more information, please consult your PNC Advisor or contact PNC Private Bank.