At retirement or separation from employment, many people often choose to take part of their k money as a taxable distribution, especially if they are cash-strapped. Having an unpaid loan balance has similar tax consequences to making this choice. Most plans do not require plan distributions at retirement or separation from service. People who want to avoid negative tax consequences can tap other sources to repay their k loans before taking a distribution.
If they do so, the full plan balance can qualify for a tax-advantaged transfer or rollover. The more serious problem is to take k loans while working without having the intent or ability to repay them on schedule. In this case, the unpaid loan balance is treated similarly to a hardship withdrawal , with negative tax consequences and perhaps also an unfavorable impact on plan participation rights. Regulations require k plan loans to be repaid on an amortizing basis that is, with a fixed repayment schedule in regular installments over not more than five years unless the loan is used to purchase a primary residence.
Longer payback periods are allowed for these particular loans. The IRS doesn't specify how long, though, so it's something to work out with your plan administrator. Borrowing from a k to completely finance a residential purchase may not be as attractive as taking out a mortgage loan. Plan loans do not offer tax deductions for interest payments, as do most types of mortgages. And, while withdrawing and repaying within five years is fine in the usual scheme of k things, the impact on your retirement progress for a loan that has to be paid back over many years can be significant.
However, a k loan might work well if you need immediate funds to cover the down payment or closing costs for a home. It won't affect your qualifying for a mortgage, either. Since the k loan isn't technically a debt—you're withdrawing your own money, after all—it has no effect on your debt-to-income ratio or on your credit score, two big factors that influence lenders. If you do need a sizable sum to purchase a house and want to use k funds, you might consider a hardship withdrawal instead of, or in addition to, the loan.
Arguments that k loans "rob" or "raid" retirement accounts often include two flaws: They assume constantly strong stock market returns in the k portfolio, and they fail to consider the interest cost of borrowing similar amounts via a bank or other consumer loans such as racking up credit card balances. Don't be scared away from a valuable liquidity option embedded in your k plan.
When you lend yourself appropriate amounts of money for the right short-term reasons, these transactions can be the simplest, most convenient, and lowest-cost source of cash available.
Before taking any loan, you should always have a clear plan in mind for repaying these amounts on schedule or earlier. Mike Loo, vice president of wealth management at Trilogy Financial , puts it this way, "While one's circumstances in taking a k loan may vary, a way to avoid the downsides of taking one in the first place is preemptive.
If you are able to take the time to preplan, set financial goals for yourself, and commit to saving some of your money both often and early, you may find that you have the funds available to you in an account other than your k , thereby preventing the need to take a k loan.
Internal Revenue Service. Securities and Exchange Commission. Employee Benefits Research Institute. Changes in k Plan Account Balances, — ," Page Accessed March 3, Employee Benefit Research Institute. Loan Basics. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page.
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Retirement Planning K. Table of Contents Expand. When a k Loan Makes Sense. Top 4 Reasons to Borrow. More than 1 in 4 of Americans have tapped into their retirement accounts or are planning to do so during the pandemic, according to a recent study by personal finance site Bankrate. Remain consistent in your payments no matter how small they are. Read more: k Plans and how it works. Make sure to consider other debts that need to be paid. Almost 1 in 6 who tapped their retirement savings said they already had additional debt.
If you have taken out a k loan, experts warned that leaving a job means you have to pay back the full amount right away. We think it's important for you to understand how we make money. It's pretty simple, actually. The offers for financial products you see on our platform come from companies who pay us. The money we make helps us give you access to free credit scores and reports and helps us create our other great tools and educational materials. Compensation may factor into how and where products appear on our platform and in what order.
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Provided your k plan permits loans, borrowing from your k may help you pay bills, fund a big purchase or make a down payment on a home. If your employer provides a k retirement savings plan, it may choose to allow participants to borrow against their accounts — although not every plan will let you do so. As long as you have a vested account balance in your k , and if your plan permits loans, you can likely be allowed to borrow against it.
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