Borrowing or Withdrawing Money from Your 401(k) Plan

Borrowing or Withdrawing Money from Your 401(k) Plan

March 05, 2024
If you have a 401(k) plan at work and need some cash, you might be tempted to borrow or withdraw money from it. But keep in mind that the purpose of a 401(k) is to save for retirement. Take money out of it now, and you'll risk running out of money during retirement. You may also face stiff tax consequences and penalties for withdrawing money before age 59½. Still, if you're facing a financial emergency — for instance, your child's college tuition is almost due and your 401(k) is your only source of available funds — borrowing or withdrawing money from your 401(k) may be your only option.

Plan loans

To find out if you're allowed to borrow from your 401(k) plan and under what circumstances, check with your plan's administrator or read your summary plan description. Some employers allow 401(k) loans only in cases of financial hardship, but you may be able to borrow money to buy a car, to improve your home, or to use for other purposes.

Generally, obtaining a 401(k) loan is easy — there's little paperwork, and there's no credit check. The fees are limited, too — you may be charged a small processing fee, but that's generally it.

How much can you borrow?

No matter how much you have in your 401(k) plan, you probably won't be able to borrow the entire sum. Generally, you can't borrow more than $50,000 or one-half of your vested plan benefits, whichever is less. (An exception applies if your account value is less than $20,000; in this case, you may be able to borrow up to $10,000, even if this is your entire balance.) Your plan may also allow you to borrow up to $100,000 (or 100% of your vested plan benefits, whichever is less) if used for recovery from a federally-declared disaster.

What are the requirements for repaying the loan?

Typically, you have to repay money you've borrowed from your 401(k) within five years by making regular payments of principal and interest at least quarterly, often through payroll deduction. However, if you use the funds to purchase a primary residence, you may have a much longer period of time to repay the loan.

Make sure you follow to the letter the repayment requirements for your loan. If you don't repay the loan as required, the money you borrowed will be considered a taxable distribution. If you're under age 59½, you'll owe a 10% federal penalty tax, as well as regular income tax, on the outstanding loan balance (other than the portion that represents any after-tax or Roth contributions you've made to the plan).

What are the advantages of borrowing money from your 401(k)?

  • You won't pay taxes and penalties on the amount you borrow, as long as the loan is repaid on time
  • Interest rates on 401(k) plan loans must be consistent with the rates charged by banks and other commercial institutions for similar loans
  • In most cases, the interest you pay on borrowed funds is credited to your own plan account; you pay interest to yourself, not to a bank or other lender

What are the disadvantages of borrowing money from your 401(k)?

  • If you don't repay your plan loan when required, it will generally be treated as a taxable distribution.
  • If you leave your employer's service (whether voluntarily or not) and still have an outstanding balance on a plan loan, the outstanding amount of the loan will be considered a distribution. You'll usually be required to repay the amount in full [or roll over the amount to another 401(k) plan or IRA] by the tax filing deadline (including extensions) of the year following the year the amount is determined to be a distribution (i.e., the year you leave your employer). Otherwise, the outstanding balance will be treated as a taxable distribution, and you'll owe a 10% penalty tax (if you're under age 59½) in addition to regular income taxes.
  • Loan interest is generally not tax deductible, with few exceptions.
  • In most cases, the amount you borrow is removed from your 401(k) plan account, and your loan payments are credited back to your account. You'll lose out on any tax-deferred (or, in the case of Roth accounts, potentially tax-free) investment earnings that may have accrued on the borrowed funds had they remained in your 401(k) plan account.
  • Loan payments are made with after-tax dollars.

Hardship withdrawals

Your 401(k) plan may have a provision that allows you to withdraw money from the plan while you're still employed if you can demonstrate "immediate and heavy" financial need, have exhausted all other available distribution options (and, possibly, loan options) from your retirement plans, and have no other resources you can use to meet that need (e.g., you can't borrow from a commercial lender and you have no other available savings). It's up to your employer to determine which financial needs qualify. Many employers allow hardship withdrawals only for the following reasons:

  • To pay the medical expenses of you, your spouse, your children, your other dependents, or your primary plan beneficiary
  • To pay the burial or funeral expenses of your parent, your spouse, your children, your other dependents, or your primary plan beneficiary
  • To pay a maximum of 12 months worth of tuition and related educational expenses for post-secondary education for you, your spouse, your children, your other dependents, or your primary plan beneficiary
  • To pay costs related to the purchase of your principal residence
  • To make payments to prevent eviction from or foreclosure on your principal residence
  • To pay expenses for the repair of damage to your principal residence after certain casualty losses
  • To pay expenses and losses (including loss of income) incurred as a result of a disaster declared by the Federal Emergency Management Agency, such as a hurricane or wildfire (provided the participant's principal residence or place of employment is located in the federally declared disaster area)

Note: You may also be allowed to withdraw funds to pay income tax and/or penalties on the hardship withdrawal itself, if these are due.

Your employer may require that you certify your need for a hardship withdrawal in writing. Also keep in mind that you will have to pay regular income taxes on any amounts withdrawn, and possibly a 10% penalty if you are younger than 59½.

How much can you withdraw?

Depending on plan rules, you may be able to withdraw your contributions, safe harbor employer contributions, and your employer's qualified nonelective and matching contributions, as well as earnings on those contributions. Check with your plan administrator for more information on the rules that apply to withdrawals from your 401(k) plan.

Other withdrawal options

Your employer may also allow you to take penalty-free distributions in certain circumstances. The following types of withdrawals will be subject to regular income tax but will avoid the 10% early distribution penalty:

  • Separation from service (i.e., if you leave the employer) after age 55
  • Under a series of substantially equal periodic payments
  • Total and permanent disability
  • Death of the plan participant, with proceeds being paid to a beneficiary
  • Certain distributions to qualified reservists called to active duty
  • Up to $5,000 for the birth or adoption of a child
  • Up to $22,000 for economic losses caused by federally declared disaster
  • Up to 50% of the account balance or $10,000, whichever is less, for plan participants who are victims of domestic abuse
  • Payments due to comply with a Qualified Domestic Relations Order
  • One personal or family emergency per year, up to $1,000 (restrictions may apply)
  • Distributions from a pension-linked emergency savings account
  • Terminal illness of the plan participant
  • To pay for certain long-term care insurance policies (beginning in 2025)

Proceed with Caution

Although tapping your 401(k) plan may be tempting, it's best to reserve this option for true emergencies only. In addition to taxes and possible penalties, perhaps the main drawback to a distribution is that the money you withdraw will no longer be benefitting from tax-deferred growth for your future.