Most 401(k) plans allow you to borrow money from your account. Some plans allow loans only for specific situations, which may include buying a home, medical expenses or college tuition. Each plan has limits on how much you can borrow: in general, no more than 50% of the account’s value, up to $50,000 maximum.
You will pay interest on your 401(k) loan at a rate determined by your plan, usually 1 to 2 percentage points above the prime rate (the interest rate charged by banks to their best customers). The interest you pay goes back into your 401(k) account. The loan typically must be repaid within five years. If you are borrowing to buy a home, the repayment period can be longer. The loan payments will be taken out of your paycheck after taxes are deducted. When you retire and take out the money, you will pay tax on it again – yes, you are being taxed twice on money you borrow! And unlike a home equity loan, you won’t get a tax deduction on interest you pay.
If you leave your job, the loan is due immediately.
If you are unable to repay the loan, the loan is considered a cash withdrawal, so you’ll have to pay income tax on it – and the 10% early withdrawal penalty if you are under age 59 ½.
Taking a loan slows the growth of your 401(k) money if you can’t keep making your regular 401(k) contributions while repaying the loan. And if you stop making contributions, you will lose your employer match – a double hit to your nest egg.