How 401(k) Loans Work: What to Expect - YouTube

A 401k loan can provide a substantial amount of money when you need

it, but before you go down that road, it's a good idea to

understand how exactly the process works and get an idea of some of

the pros and cons of tapping your retirement savings. You probably already

know this, but just briefly, a 401K loan is best used as a

safety net, but in some cases, it's the only option you've got,

so it makes sense to tap your retirement savings. In the next couple

of minutes, we will talk about how these loans work, so the logistics

of getting one, what are the rules associated with it. We're also going

to talk about repaying the loans, how exactly does that work,

and what happens if you don't repay? And we'll cover some costs and

some risks, so that you get an idea of exactly what you might

be getting into. Just a friendly reminder that this is just a short

video so it can't tell you everything you need to know,

it's critical to check with your employer and the plan administrator,

and it's a very good idea to check with some professionals like a

tax, legal, and financial planner, that's the best way to avoid problems.

And of course, you can find information about working with me in the

description. So let's start with some basics about 401 loans. One of the

most important things to know is that not every 401k offers loans.

This depends on what your employer chose when they set up the 401K

plan, so some employers say, "I don't want to encourage people to tap

their savings," others say "it's their money, they can do whatever they

want with it." First thing you need to know is, do you have

loans available in your plan? If your plan does not allow 401K loans,

you might be able to access your money with a hardship withdrawal,

so that is also something your employer needs to enable on the plan,

and it's also something you need to qualify for, so you might need

to be avoiding insolvency or purchasing a primary residence or paying medical

expenses. So check on that if you need the money, but you don't

have loans available. The option to borrow is typically only available to

current employees, so if you have money in an old 401 at your

previous job, you cannot borrow from those funds, although you might be

able to move money from an old 401K to your current jobs,

401k or maybe from an IRA, and that may help build up your

balance that you can borrow from... So how much can you borrow?

You can typically get up to 50% of your vested balance or $50,000, whichever

is less. So if you have over $100,000,

you might be able to get up to 50,000.

If you have less, let's say you have 24,000,

you could borrow up to half of that or 12,000. It's important to

know what your vested balance is. I have a separate video on vested

balances. But the point is that this is the money you own in

the 401k, so any money that you voluntarily contribute out of your pay

is 100% immediately vested, that is your money, but there might be other

money types in your 401k, so if your employer matches your contributions

or if they put in profit sharing contributions, those might not be available

to you to borrow, so again, check with your employer to get the

details on that. A few other things to know is that there is

no credit check, so you don't qualify for a 401 loan like you

would for a personal loan or a mortgage or something like that.

Your credit doesn't matter as long as you have a vested balance in

the plan and the plan allows loans and you're eligible to borrow,

then you can typically get a loan... Another thing to know is that

previous loans can interfere with your ability to borrow, so if you have

taken a loan in the past or you have an outstanding loan right

now, you definitely want to ask your employer if you can borrow again

or if you need to do something first, perhaps wait, before you get

the loan that you're looking for today. So how exactly do you get

a loan when you're ready to borrow? It's a matter of getting with

your employer and requesting the loan, so you might go to your HR

department, your benefits department, or if you're in a very small company,

talk to whoever hired you and ask, Can I get a loan? And

how exactly do I do that? To complete the process, you're going to submit

a request, that might be something that you do on paper with a

form, or it might be something that you can request online,

that's typically the fastest and the easiest way to get your funds,

but it just depends on your plan, and typically with bigger companies,

you've got more options to do this maybe in an app or request

it online. You submit that request and then there is some waiting involved,

and this is what trips a lot of people up. Getting a loan can

take anywhere from a day or two to several weeks, and it can

even go longer if your employer is not very organized and responsive.

So you request a loan and then some people at different companies perhaps

need to review that request and approve it, so typically they go quite

quickly. If everybody's paying attention, but it does take a couple of different

people sometimes to approve that loan, then the request goes to a recordkeeper,

which might be a separate company, that might be the company that you

log into when you want to move your funds or look at your

account balance, and that's the company that actually sends you the money,

now, if they send it electronically, a wire transfer can hit your account

within one business day, or an ACH transfer can hit within a couple

of days, but if they mail a check, then that slows things down.

With a check, the recordkeeper typically prints it, it goes out the next

day, and then it's got to go through the mail. Once you finally

get the check, you deposit it, and you may have to wait for

the check to clear at your bank, which can take a couple of

extra days, so just be aware of the timeline and keep that in

mind as you go through the process. If you have an urgent need,

you're going to want to ask a lot of questions and find out

how long does this take? What is the payment method and what options

do I have to expedite that? Once you get your loan,

you start repaying, and we'll talk about that in just a minute,

but let's get into some potential pitfalls and just the cost you pay

to borrow with a 401 loan, now you pay interest on the loan,

just like with any other loan, that interest goes into your account,

so you're essentially paying yourself, and a lot of people view that as

a great thing, and that can be good, and that's especially the case.

If the markets were going to go down and you take money out

and pay your self interest on that balance. That actually works out quite

well. But there is also an opportunity cost, so if the markets were

going to go up and you're invested, let's say aggressively, you would potentially

miss out on some of that upside, so you could potentially have less

money to spend in retirement because you might reach retirement with a smaller

account balance. Now, if you're wiping out toxic debt or paying for emergency

medical expenses or something like that, the price may be well worth it,

but it's just important to know that there are trade offs when you

borrow from your 401. The interest rate is typically something that's based

on the prime rate, and then there may be an extra percent or

so on top of that, that's just something you would ask your employer,

there is usually also some sort of administrative fee, so it might be

$100 when you first take out the loan, plus $50

every year that you keep the loan outstanding, it's not a huge cost

in most cases, but it's something to be aware of. There might also

be some taxes due if you're unable to repay the loan according to

the loan rules, so if you just borrow and repay... There's no big

tax consequence, but if you're not able to repay that loan,

then the IRS treats it as a distribution, so that might be a

bunch of pre tax money, and the IRS says it's essentially like you

receive that as ordinary income, which will be taxable to you...

So that's going to go on top of any other income you had

during the year, so let's say you had a $40,000 loan balance outstanding,

then it would be as if you earned an extra 40,000,

if you're in... Let's say the 25% tax bracket, federal and state combined,

for example, yours might be higher or lower, but that would be $10,000

of income tax. And if you're under age 59 and a half,

there might be an additional 10% penalty on top of that.

So 10% of 40,000 is $4,000, then you're looking at $14,000 that is

due. So you took a loan probably because you needed money,

and if all goes badly, you may end up owing quite a bit

of money to the IRS, which only makes things worse. This doesn't happen

to everybody, but it's important to know about as you evaluate the decision.

But let's be optimistic and assume that you repay the loan and everything

goes well, so the way that works is the money comes out of

your paycheck or the earnings that you have, your employer automatically

takes that money and puts it toward the loan, there are no tax

benefits to these payments you make, unlike maybe pre tax 401K contributions,

you don't get to reduce your taxable income when you make these loan

repayments, but if you think about any other loan, you are not getting

deductible payments on most other loans as well. An auto loan,

a personal loan. The repayment period is typically five years. Now that

can be extended if you're getting a loan for a personal residence,

it can go up to 30 years, but your employer gets to decide

on that. So in most cases, you're going to look at an amortization

schedule or a repayment schedule that satisfies the loan balance over five

years, so you want to budget for that, but this brings up the

question of what happens if you leave your job because you might not

stay in the same place for five years or 30 years,

for that matter, so when you leave your job, whether you quit,

you're fired, whatever the case may be, you typically have an opportunity

to repay the loan at that point, and that is a good idea,

that's what prevents the IRS from saying that you took a distribution.

So if you can just write a check. That's ideal. But again,

you probably borrowed the money because you needed some money, and you don't

have all of that money sitting around in your checking account.

If you do leave your job, then it's important to talk with the

plan provider and talk with your tax preparer as soon as possible to

figure out how you want to deal with this. In some cases,

you're able to actually repay the loan later to an IRA,

and that's typically within the next tax filing deadline plus extensions,

but you really need to get those details nailed down with your CPA

and have a solid plan before you count on doing that.

Well, I hope this has been helpful. Please leave a quick thumbs up

to get more information like this and take care.