Take a 401k loan: What you should know

After years of regular contributions, a 401(k) plan through your employer may become one of your largest financial assets. In some cases, your employer may also allow you to borrow against the funds in that plan, which may be another financial benefit to you.

As you continue to work and build for your retirement, you may be tempted to take a loan to cover emergencies or big expenses like college. But before you make that decision, there are some things you should know about 401k loan rules.

What is the 401k loan limit?

With a 401k loan, you can generally borrow up to 50% of the vested account balance in your 401k account, or $50,000 whichever is less.

What are the 401k loan repayment rules?

There are requirements for repayment of a 401k loan. First, the money has to be repaid, usually over a five-year period. If you quit, are laid off, or if the 401k plan is terminated, the loan will typically become due within 60 days. This could be a big financial strain on you in addition to setting back your retirement saving.

Another drawback is that if the loan is not repaid when due, then the balance will be treated as a withdrawal, and may be subject to income tax as well as a 10% penalty tax if you are younger than 59 1/2 years old.

How is 401k loan interest paid?

You'll have to pay the money back with interest. The good news is, the interest is credited to your 401k account, not to your employer, so you are paying the money back to yourself. Paying the loan back comes right out of your paycheck too. So keep in mind this will lower your take home pay until the loan is paid back.

Use for emergencies only

If you face a serious financial need, borrowing money from your 401k plan may make sense, as it can be easy to get. But consider it only after you've exhausted your cash savings accounts. Keep in mind if you leave your employer for any reason, a 401k loan can create a major financial burden.