Can I Borrow From My 401(k) and Pay It Back?

By: Steven Melendez | Updated November 10, 2018

If you have a 401(k) retirement plan from work, you can often borrow money from it under terms specified in the plan. If you just take a withdrawal, you'll generally owe a tax penalty if you're under retirement age. You can't take a loan from an individual retirement arrangement, but there are more circumstances where you're allowed to take an early withdrawal without a penalty than for a 401(k).

How 401(k) Accounts Work

A 401(k) is a type of retirement account that your employer can open for you. You can't set one up for yourself unless you're self-employed. You can put money into it every year, usually through paycheck withdrawals distributed throughout the year, and you don't pay federal income tax on the money you put into the account. Some employers will make matching contributions to your 401(k) based on how much you put in.

When you reach age 59 1/2, you can start making withdrawals from the account, paying tax on the money at that time. If you make withdrawals before that age, you must show evidence it is due to economic hardship and you generally must pay a 10 percent tax penalty as well as the deferred tax.

When you leave a job, you can roll the 401(k) over to a new 401(k) at a new employer or to an IRA and not pay a penalty if you follow IRS rules.

Taking a 401(k) Loan

Some employers enable you to take a loan from your 401(k) balance with interest being paid back into your account when you repay the loan. Generally under IRS rules you must pay the loan back within five years. You can borrow up to 50 percent of your vested balance in the account, or up to $50,000, whichever is less.

However, if you have less than $20,000 in the account, the IRS allows a loan amount up to $10,000, even if that's more than half your account balance. If you leave your job, you may have to pay the loan back on a tightened schedule.

If you don't follow the loan terms, you may be considered to have taken an early withdrawal, leading to a tax liability and penalties. This can make a 401(k) loan riskier than other options for accessing fast cash.

Paying the Loan Back

Make sure you understand the loan terms, including interest and how you actually repay the money, if you take a 401(k) loan. Often you can pay the money back through additional withdrawals from your paycheck.

You do pay tax on the funds to repay the loan, unlike the money you initially put into the account. Often if you leave your job or are fired, you must pay the loan back within 60 days or see it treated as withdrawal subject to income tax and early withdrawal penalties.

Sometimes you can pay a loan back in a longer time period than the usual five years if you're using the funds to buy a house.

IRAs and Early Withdrawals

Like a 401(k), a traditional IRA is a retirement account that you can put money into as you are working, earning a tax deduction. When you turn 59 1/2, you're able to start withdrawing money from the account without penalty, though you do have to pay tax on the money you withdraw. You can set up an IRA for yourself with a variety of banks and other financial institutions and can contribute up to $5,500 per year in earned income to the account or up to $6,500 if you are 50 or older.

Early withdrawals are permissible from an IRA in certain circumstances without a tax penalty, including to pay for health insurance for yourself and your family while you're unemployed or to pay for certain medical expenses. People who are called to active duty from the military Reserves or the National Guard are also often allowed to take withdrawals with no penalty. Early withdrawals are also allowed to pay for certain educational expenses for yourself and your family. You can also use up to $10,000 toward the purchase of a house if you're a first-time homebuyer.

If you have an IRA and a 401(k), it may make more sense to take an early IRA withdrawal for a permissible purpose than to borrow against the 401(k).

Roth IRAs

Roth IRAs are a special type of IRA. Unlike with a traditional IRA, you pay tax on money as you earn it and then deposit it into the Roth IRA. When you withdraw money after retirement age of 59 1/2, you do not pay tax on the money you take out of the account, including any investment earnings or interest. This can be a good option if you anticipate being in a high income tax bracket in retirement age or earning a lot of money with your investments.

The rules for taking early withdrawals allow you to take your deposits back from the Roth account without a tax penalty or other tax consequences, other than the fact that your investment earnings will likely be diminished. Early withdrawals of earnings, though, are subject to income tax and a 10 percent penalty.

Exceptions apply if you're withdrawing money up to $10,000 for a first home, if you're disabled or once you hit retirement age.

Required Minimum Distributions

Once you reach age 70 1/2, you generally must begin taking a certain amount of money out of your traditional 401(k) and IRA accounts, or face a tax penalty. These withdrawals are called required minimum distributions.

You can find the amount you must withdraw based on your age and account balances using calculators from the IRS or third-party sites, including some brokerages. The tax penalties can be 50 percent of the amount you failed to withdraw, which is substantially more than you would pay in tax on a withdrawal at any tax bracket.

Rolling Over Funds

You can transfer money from a 401(k) or an IRA to another retirement account without it being treated as a 401(k) withdrawal or IRA distribution. Generally you can only do so for a 401(k) once you leave the company where you had the account.

Work with the financial institutions involved to have the money sent directly from one account to another. If you take possession of the funds, you may face withholding tax and a tight deadline to deposit in a new qualified retirement account. If you miss the 60-day deadline, you will owe tax as if you had made a withdrawal from the account.

You can't borrow from an IRA, but you can do something similar if you remove money from the account and return it within the 60-day period. The frequency of this "remove and return" loophole is limited to prevent abuse.

Borrow Against Other Investments

You can borrow against other investments as well, such as a brokerage account, if your financial institution allows it. This can often save you money as opposed to selling your stocks if they continue to appreciate.

If you have assets in nonretirement accounts, this may be a better option than borrowing from a 401(k) or taking an early withdrawal from an IRA. Check with your financial institution to understand the rates and loan terms. You generally can't borrow against an investment account to buy more securities.

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About the Author

Steven Melendez is an independent journalist with a background in technology and business. He has written for a variety of business publications including Fast Company, the Wall Street Journal, Innovation Leader and Ad Age. He was awarded the Knight Foundation scholarship to Northwestern University's Medill School of Journalism.

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