You have financial woes and need urgent money. You probably know that there are payday loans, personal loans, and credit cards to borrow money, but you find that their cost is relatively high. So you think about borrowing money from your 401(k).
So how can you quickly and successfully borrow money from your 401(k)?
This ultimate guide will cover everything you need, including the detailed steps, benefits, risks, and alternatives.
A Step-By-Step Guide to Borrowing From a 401(k)
Fidelity and Principal are both popular financial service companies offering 401(K) plan services in the U.S. If you use any of their retirement savings services, their plans allow you to borrow or withdraw money from your account easily.
Below is how to borrow and withdraw from your 401(k) on Fidelity and Principal respectively in simple straightforward steps.
Take a Fidelity 401(k) Loan in 7 Steps
Step 1: Log into your Fidelity account via NetBenefits.com
Step 2: Select your 401(k) account to access your dashboard.
Step 3: Go to Request Or View A Loan Or Withdrawal on the 401(k) homepage, then click on See Your Options.
Step 4: From the loan options, choose one between the general loan and home loan and click on Explore This Option
Step 5: Enter a loan amount within your given range, select the preferred loan length (term), and click Calculate. You will be shown your loan details, including interest rate, total interest, maintenance fee, payment frequency, payment dates, the amount payable, and more.
Step 6: If satisfied with the loan term, fees, and payments, click on Begin Loan Request to apply.
Step 7: Wait for approval and get funded within the stipulated time.
Features of Fidelity 401(k) Loan
1. General Fidelity 401(k) loans have a 5-year maximum loan term, while home loans have 10 years.
2. The maximum interest is 7.5%.
3. No paperwork is required to take a 401(k) loan on Fidelity.
4. The amount you can borrow is set based on your current savings.
5. Funding happens within two to seven days.
6. There will always be a one-time $75 maintenance fee for each 401(k) loan you take.
7. Fidelity deducts your weekly, biweekly, monthly, or quarterly payments from your paychecks.
Withdraw Money From Your Fidelity 401(K) in 5 Steps
Step 1: Go to your Fidelity account via NetBenefits.com
Step 2: Go to your 401(k) dashboard and select Request Or View A Loan Or Withdrawal
Step 3: Click on See Your Options, choose a withdrawal plan, and tap Explore This Option.
Step 4: Enter the amount you wish to withdraw and click Calculate. You will see all the penalty fees applicable to your withdrawal.
Step 5: If satisfied, click on Begin Withdrawal Request and await approval.
Features of Fidelity 401(k) Withdrawal
1. Paperwork is required for an early 401(k) withdrawal on Fidelity.
2. Delivery takes from two to seven days.
3. You will be charged taxes, fees, and IRS penalties, depending on your withdrawal amount.
Take a Loan From Your Principal 401(k) in 7 Steps
Step 1: Log into your Principal Account via Principal.com
Step 2: Click on Loans And Withdrawals from the homepage.
Step 3: Select Explore A Loan, choose between the general loan and the primary residence loan, and click Quote A standard loan or Quote A Primary residence loan
Step 4: Enter a loan amount, confirm your residence and select the preferred loan term.
Step 5: Review the details of your loan, including the amount, payment frequency, total number of payments, total payment amount, interest rate, setup fee, and more. Proceed to the next stage.
Step 6: Check out the delivery options and select one, then await final review.
Step 7: Expect the funding within the set date.
Features of Principal 401(k) Loan
1. General loans on principal 401(k) have a 5-year maximum loan term, while the primary residence loans have up to 15 years terms.
2. You need proof, like a purchase contract to get a primary residence loan.
3. Loan processing takes up to 3 days.
4. No early repayment fees apply.
5. The maximum interest is 6.5%.
6. There is a loan maintenance fee of $12 quarterly.
7. The setup fee is constant and costs $75 per loan.
8. Principal accepts repayment throughout paycheck deductions.
9. You can only borrow one loan at a time.
Withdraw Money From Your Principal 401(k) in 7 Steps
Step 1: Log into your Principal Account via principal.com
Step 2: Select Loans and Withdrawals.
Step 3: Click on Explore a withdrawal.
Step 4: Select Hardship Withdrawal.
Step 5: Enter a withdrawal amount within your given range and fill in all other required information.
Step 6: Review your withdrawal details, including the applicable fees and penalty charges.
Step 7: Check and select delivery options, and await final review.
Feature of Principal 401(k) Withdrawal
1. Taxes and penalties are charged on early Principal 401(k) withdrawals.
The Best Option is 401(k) Loans
Through the comparison of multiple dimensions, generally speaking, taking a 401(k) loan is better than a 401(k) withdrawal.
A 401(k) Loan is Better Than a 401(k) Withdrawal
The most significant benefit of a 401(k) loan is no taxes or penalties when you borrow from your 401(k) account.
A 401(k) loan is an advance you can get from your 401(k) retirement savings, according to the rules of your employer's plans.
Like every other loan, you must pay interest with the principal amount within a set period. But any interest paid on the amount borrowed will go back into your 401(k) account so you can make a profit on the loan.
A 401(k) withdrawal, as opposed to a loan, is a permanent removal from your 401(k) account. You, however, have to pay regular income taxes when you make withdrawals, and it has possible penalties that may apply. You should only consider this as a last resort.
The Pros and Cons of Taking a 401(K) Loan
Pros
- As opposed to other means of borrowing, there are no taxes or penalties when you borrow from your 401(k) account.
- Any interest paid on the borrowed sum is paid back to your 401(k) account, so you make a profit from your loan.
- It does not require a credit check and is not reported as debt on your credit bureau. Therefore, your credit score will not be affected.
- You can borrow up to 5% of your account balance or $50,000 within a year, depending on which is less.
Cons
- You might have to repay loans in the full and short term (typically a few months) if you leave your job within the loan period.
- You might pay penalties and additional taxes of up to 10% if you default on your 401(k) loan because outstanding loan balances are handled as taxable income.
- You have less money saved in your retirement fund for any unpaid loan.
- Whatever interest you pay cannot compare to the profits the loan would amass if invested in a good stock or left untouched.
The Pros and Cons of a 401(K) Withdrawal
Pros
- You don’t have to pay it back.
- There are no penalties if you withdraw at 59½ years or older. Or you may escape the penalties if you meet IRS exemption criteria.
Cons
- You get less than the amount you borrowed because withdrawals are taxed as ordinary income (The federal income tax and the relevant state income tax).
- If you withdraw before the age of 59½ years, you pay a 10% early withdrawal penalty on the amount you withdraw.
You can avoid paying the 10% early withdrawal penalty by requesting a hardship withdrawal. Hardship withdrawals are put in place to cover specific circumstances like:
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Medical bills for you, your spouse, or dependents.
Funeral expenses.
Pay for a primary residence or to avoid foreclosure.
Pay for home repairs following a natural disaster.
If you become permanently disabled.
Hardship withdrawals may work fine for you, but consider its advantages and disadvantages before deciding.
You Should Know 6 Key Information before Taking Loans from 401(k)
You Can Get Up to $50,000 From 401(K) Loans
Generally, you can borrow money concerning your funds in your 401(k) account. You should also refer to your employer's specifications on this. The table below gives an overview:
| Total Amount Available In Your 401(k): | Amount Up For Borrowing: |
|---|---|
| $100,000 or more. | $50,000 |
| $10,000 to $100,000 | 50% of your vested value |
| $10,000 or less | $10,000 |
The Repayment Period is 5 Years
You are allowed to repay your 401(k) loan within five years. According to the IRS, you must repay your loan, with interest as specified by your workplace terms, within five years of taking it out. It is usually deducted from your payroll automatically.
However, you can have up to a 25 years repayment period if the money is being used for your mortgage. Such loans are expected to be repaid substantially equal amounts (Principal plus interest rate) at least every four months. You may also pay back the loan through regular deductions from your paychecks.
Borrowers can pay back their 401(k) loans early if they want without attracting any penalty. So, you may increase your payroll deductions and pay off your loan before the allotted 5-year plan is due.
If you default on your 401(k) loan repayment, you would be made to pay taxes, such as an income tax, because any outstanding balance is treated as taxable income. Also, a 10% penalty would apply if you’re below the retirement age.
You May Only Be Able to Borrow as Often as Your Employer’s Rules Allow
Most employers usually allow one loan at a time, meaning you can take another loan only when you have settled the previous one. So you may only be able to borrow as often as your employer’s rules allow.
Please note that regardless of your employer’s rules, you cannot go past the withdrawal limit provided by the IRS.
According to the IRS, you can only borrow 50% of your entire retirement savings or $50000, whichever is less.
What is The Consequence of Leaving My Job Before Repaying My 401(k) Loan?
If you don't finish repaying your 401(k) loan before leaving your job, you may have to pay tax on the outstanding amount.
Usually, you would have to pay back the loan in full until the next tax return filing date; otherwise, your account balance will be reduced by the outstanding amount and considered a distribution.
However, that distribution becomes taxable if you cannot pay the amount owed into a qualified retirement account. Also, if you leave the job before age 59½, there will be a 10% early withdrawal penalty.
In addition, your company may have set rules for withdrawal and borrowing. So, there may be additional penalties when you leave your job before repaying your loan.
Does My Employer Know When I Take A 401(k) Loan?
Your company's HR usually processes the loan, but your employer will be informed about the arrangement. So, your employer will most likely be aware if you take a loan from your 401(k).
How to Manage My 401 (K) If I Change My Job?
After changing your job, you can do one of the following with your 401(k):
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Take your savings and put them in your new employer's 401(k) plan
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Withdraw your old 401(k) fund
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Keep the balance in your old 401(k) with your former employer's plan
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Roll over your 401(k) account funds into an IRA.
When Does Borrowing from 401(k) Make Sense?
You can turn to your 401(k) fund to settle emergencies or to pay off high-interest debts. But it is not recommended to indulge in material comforts.
For example, borrowing from your 401(k) account to settle emergencies like a leaking roof, mortgage payment, or home improvement projects is not bad. Such projects raise your property's value, making them a worthwhile investment.
You could also use a 401(k) loan or withdrawal to pay off high-interest debts that could accumulate more fees if unpaid. Such debt payment has a long-term benefit as it helps reduce the amount you pay to lenders as interest. Also, 401(k) loans or withdrawals will not affect your credit score, unlike other loan types.
However, there are some situations where you can avoid touching your retirement savings, like throwing a house party, buying gifts, and other stuff that is not necessary. Such expenses do not bring returns and, as such, do not have any tangible benefits.
Whenever you are ready to take a 401(k) loan, the following tips will help;
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Do not stop saving for retirement, whether you withdraw or take a loan from your 401(k).
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Ensure you pay off your 401(k) loan entirely and on time. Don't delay repayment just because it will not affect your credit score.
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Try only to borrow what you need and avoid borrowing too frequently.
You should not lose sight of your initial post-retirement plan at any point. Even while paying for your 401(k) loan, you should continue contributing to your retirement savings account.
6 Alternatives to Borrowing from 401(k)
Borrowing from 401(k) has drawbacks, like paying penalties and additional taxes of up to 10% if you default on your 401(k) loan.
Furthermore, most borrowers pause funding their retirement savings accounts until they fully repay the loans causing less money saved for life after retirement.
So it is advisable to consider the following 6 alternatives.
1. Consider A Personal Loan
Personal loans are probably the most popular loan type available. They generally have fast processing time and offer borrowers repayment plans in installments.
Most personal loan lenders will fund your account within 24 to 48 hours after closing the deal. However, some processing may take up to one business week, depending on your lender's speed.
Personal loans attract interest rates and some extra fees for processing, late payment, and sometimes an early repayment penalty. However, despite the fees, the average APR of a personal loan is 9.39%, which is much less than the 17.13% APR on credit card cash advances.
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2. Consider a Home Equity Loan
You can try a home equity loan as an alternative to borrowing from your 401(k). It entails borrowing against your home's equity at a fixed interest rate.
Home Equity lenders usually calculate the loan amount by deducting the borrower's due mortgage balance from the home's current value.
The lenders will then give a lump sum which you are expected to repay with the agreed interest rate over a set period, usually between 5 to 15 years. Note that if the house on which the equity is based gets sold, you must repay the loan in full.
3. Consider A HELOC (A home equity line of credit)
A HELOC is a variant of the home equity loan but with a revolving line of credit.
It allows you to draw loans multiple times, usually within five to ten years. After the draw period, you must repay the loans in the next 10 to 20 years at the agreed interest rate.
HELOCs usually have a flexible interest rate, which may vary based on each draw period. However, some lenders do offer HELOCs at a fixed interest rate.
4. Consider Using HSA When You Have A Qualified Medical Expense
A Health Savings Account (HSA) may just be the most suitable funding method for you if you have to cover a medical expense. However, that is only possible if you have an HSA.
According to the IRS, only people covered under High-deductible health plans (HDHPs) can have an HSA account. When such people have qualified medical expenses, the saved funds are used to pay the fees.
To check if you have an HSA, consult your employer because they are in charge of the accounts.
5. Consider A New Lower (or zero) Interest Credit Card
Credit Card loans generally have outrageous fees, which may make you skeptical about taking them. However, a new lower-interest ( or zero-interest) credit card lets you enjoy little or no interest charges.
A 0% APR credit card usually offers an interest-free period to users on purchases and balance transfers, usually for six months to 2 years.
When you take a cash advance during that introductory period, your account will not be charged any interest fees. However, the normal APR will set in when the interest-free period ends.
6. Withdraw From a Roth IRA
If you have an Individual Retirement Account (IRA), you can withdraw from it instead of borrowing from your 401(k).
But, there is a similar penalty for early withdrawal, like 401(k). You will be charged 10% on your withdrawal if you take the funds before you're 59½.
However, you can be exempted from the penalty in some cases, such as when you withdraw to cover college expenses, first-time house purchases, adoption, or birth cost.
Summary
Deciding to borrow from your retirement savings to cover emergency needs may seem like a great solution, but is it right for you?
Before borrowing from your 401(k), it is advisable to weigh the advantages and the drawbacks you may experience from doing that.
Fortunately, this article explains, in full detail, the conditions surrounding taking out loans or withdrawing from your 401(k).
Read through again and if it isn't right for you, consider other options like getting a personal loan with a lower interest rate with CreditYelp.
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Michelle Roland has 20+ years of industry experience. She is a retired freelance writer mainly focusing on the credit industry, serving as a consumer affairs manager for FICO and account manager for Equifax.
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