A 401 (k) account is a retirement account meant to save money for your retired life. It is possible to take a loan on your 401(k) account when you need money. You need to understand the basics of the 401(k) loan so that you know everything about taking a loan on your 401(k) account.
While discussing the basics of the 401(k) loan, we need to understand what this loan is. A 401(k) account is a retirement account that is opened by your employer. Every month, money is deducted from your salary and credited to the account. If your employer agrees to contribute an equal amount, you would have a good chance of building a substantial retirement amount.
You are not allowed to withdraw money until the age of 59 and a half. Withdrawing early will lead to a penalty. However, to take care of any exigencies, there is a provision by which you can take a loan on your 401(k) account. You are essentially taking a loan from yourself and then repaying it at a lesser rate. This article mentions a few basics of taking a loan on your 401(k) loan.
There is a limit on the amount of loan that you can take. The limit is 50% of the balance vested in your account or $50,000, whichever is lesser.
Term and repayment
You can repay the loan with interest by deductions from your salary. You must note that some 401(k) plans don’t allow you to continue contributing money to your account, when you have a loan due. This can affect the final amount you get. It is in your interest to clear the loan at the earliest.
There is no penalty for early payment. So, you can repay the loan quickly. The maximum term allowed is five years.
The interest rate on 401(k) loans is usually higher than the subprime interest rate. It may be anywhere from 6.5% to 7.5%. The best part about the loan and the interest is that it does not consider your credit score. This is why many people opt for a 401(k) loan. Those who have a poor credit score can easily get a loan from their 401(k) account at a good interest rate.
The amount you put away into your 401(k) account is tax-free. Tax is due on your 401(k) account, only when you start using it after retirement. However, if you take a loan, then you need to pay tax on the interest. One should also remember that when you withdraw the money, you will be taxed again.
In case you quit your job or are sacked, you need to clear the entire loan within a year of quitting your job. Failing to do so will lead to a penalty of 10% being imposed on the due amount and you also need to pay tax on it.