There are several instances in life when you may urgently need funds. For instance, you have to pay a huge sum on your credit card bill or have a major home repair to take care of. One of the options by which you can acquire funds in needs like these, is a 401(k) loan. But, before you rush to get a 401(k) loan, why not first get down to understanding some essential 401(k) loan basics? Understanding how this loan type works would let you reap benefits rather than cost you.

Essential 401 (k) loan basics

What is a 401(k) loan?

A 401(k) loan is an arrangement that helps deal with unplanned expenses, while at the same time saving a considerable amount of money for retirement. A 401(k) loan is when you borrow funds from your 401(k) retirement savings account. A timely repayment of this loaned money with interest is the only way to safeguard savings and keep them on track.

What is the repayment like?

In the case of a 401(k) loan, the repayments are taken from the paycheck automatically after taxes and other payroll deductions. In most cases, repayments are taken on a monthly or quarterly basis. The longest repayment term that is allowed is five years. Some plans do not allow you to make contributions to your 401(k) plan while you are making repayments.

What happens if someone loses their job while making repayments?

During the payment of the 401(k) loan, you need to have a stable job at least till the time you completely repay the sum owed. In the event of someone losing their job while they have outstanding repayments for a 401(k) loan, they will have to pay the outstanding amount immediately. If the outstanding repayments are not made promptly, the person may be levied with high penalty from the IRS, or the loan may be categorized as an early distribution which would also result in them owing high taxes.

What is the maximum loan amount one can get?

You can only borrow up to 50% of the vested balance, or $50,000, whichever amount is less. Now, to explain this, let’s say you have $150,000 in your 401(k) vested account balance. So, you will just be able to borrow $50,000 and not $75,000.

How to apply for a 401(k) loan?

If your 401(k) plan has provisions for loans, you may contact your plan administrator and talk about your options. You will get to know the steps that you need to take as well as all the terms and conditions. Also, if you are married and want to borrow more than $50,000, you may need the written approval of your spouse. After the loan has been approved, you will be required to sign the loan agreement which will include the information on aspects like interest rate, loan terms, principal, and any fees that you need to be aware of.