The IRS definition of borrowing from your 401(k) plan means that you are taking out a loan that you intend to pay back. Each 401(k) plan has different rules regarding the circumstances in which borrowing may occur. IRS rules dictate that distributions from a 401(k) plan must begin in the calendar year that the participant reaches the age of 70 1/2 or retires. Distributions are distinguishable from 401(k) loans since they are not subject to repayment or borrowing limits.
Employer-sponsored 401(k) plans that permit borrowing require repayment of loan balances within five years, according to the IRS. The exception to this rule is if you use the loan to purchase a primary residence. According to IRS regulations, you may borrow up to 50 percent of your vested 401(k) balance as long as it does not exceed $50,000. The $50,000 limit includes any other existing loans from 401(k) plans that you took out within one year's time. If you have multiple 401(k) plans, it is best to check whether each one allows borrowing after retirement or separation from the company.
Reasons for 401(k) Loans
Employers may restrict the list of acceptable reasons for 401(k) loans. Some of the common reasons include higher education expenses, prevention of foreclosures or evictions, medical expenses, and home purchases. In most cases, a home purchase qualifies as long as it is not for a vacation or secondary residence. Employers often establish minimum loan amounts and interest rates. Retirees should be aware that many plans do not extend borrowing privileges to former employees. Many plans require repayment of loans within 60 days of employment termination.
The administrator of each 401(k) plan determines the minimum required distribution, which must occur once the participant retires. Plans may pay required distributions in lump sums or in regular installments, according to IRS regulations. You must receive your entire plan benefit or regular periodic distributions at retirement or by age 70 1/2. Employees that retire at age 55 and start receiving distributions will not be subject to the 10-percent early distribution tax. Borrowing from your 401(k) after retirement may not be necessary due to required distribution regulations.
Elective or non-required distributions usually cannot occur prior to retirement unless you've reached the age of 59 1/2, experience financial hardship, or become disabled. If your employer terminates its 401(k) plan and does not provide you with a suitable alternative, you may receive an elective distribution. Each employer is responsible for determining whether it will allow financial hardship distributions. According to IRS regulations, hardship distributions should be for an immediate and heavy financial need. Examples of immediate financial need include funeral and medical expenses.
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