Considering Tapping Your 401(k) For a Home Down Payment? Check Yourself
If you’re planning to take a loan out on your 401(k) to purchase a home, you better check with your employer first. Your employer’s rules on borrowing from your retirement funds might be tougher than those of the Internal Revenue Service.
According to the IRS, retirement plans may offer loans to participants but are not required to do so.
The good news is that, according to the Plan Sponsor Council of America, or PSCA, most employers — 82.8 percent — allow employees to borrow against their 401(k) funds. The bad news is that employers can put many restrictions on getting a loan.
There are even more limitations, said Nevin Adams, chief of retirement marketing and communications at the American Retirement Association.
“Each employer plan has its own rules for loans, starting with deciding to allow loans,” Adams said. “There are certain legal limits on plan loans, but the employer can set their own minimum amounts, set the number of loans, charge a processing fee and establish the rate of interest.”
There are a few serious criteria to know before taking a loan from your 401(k). If you don’t repay the loan and interest according to the loan’s terms, any unpaid amounts become a plan distribution and is reported it to the IRS. You must include this amount in your gross income in the year in which the distribution occurs.
You also may have to pay an additional 10 percent tax on the amount of the taxable distribution if you are younger than 59½ and/or do not qualify for some other exception.
Employers also may require an employee to completely repay a loan if the employee leaves the job. If the employee is unable to repay the loan, the employer will treat it as a distribution.
In addition, any unpaid loan means you have less money saved for retirement.
So is it a good or bad idea to borrow against your 401(k)?
The first step to determine whether a loan makes sense for you is to check with your plan’s administrator or read your plan description to understand the terms for obtaining a loan.
— The Washington Post