This information is provided as general guidance on the subject of 401(k) plan loans and is not provided as legal, tax or investment advice. Individual situations will vary, so please consult your tax, legal or financial advisor for more detailed information and advice.
The Ins and Outs of 401(k) Loans
In a perfect world, you'd accumulate enough money to meet your future retirement income needs and never have to touch those dollars until you retire. But we don't live in a perfect world and there may be occasions when you need to access a portion of your retirement savings before you leave the workforce. Recognizing this, your employer has selected Reserve SolutionsSM to ensure the money in your 401(k) is available to you whenever it's needed. If that time comes, your funds are available in the form of a ReservePlus loan, administered by Reserve SolutionsSM. No other loan program can provide you with the same level of convenience, security, and privacy during times of need, while never losing sight of your retirement goals.
401(k) Loans 101
What exactly is a 401(k) loan? Very simply, it's a way to meet immediate income needs by borrowing money from yourself. Then, over time, you pay the loan back with interest. However, unlike a traditional loan, such as a mortgage, the interest you pay is transferred back to your 401(k) plan account.
Here is the basic information you should know about a 401(k) loan.
- Loan Amount - Assuming that you haven't taken any other 401(k) plan loans in the last 12 months, you're allowed to borrow up to 50% of your vested account balance, up to a maximum of $50,000.
- Interest Rate - The interest rate will vary by plan, but the rates most often used are tied to the "prime rate." The current prime rate can be found in the business section of your local newspaper or The Wall Street Journal. You may also contact your Human Resources department for additional information.
- Income Tax and Penalties - The loan is not subject to any immediate income taxes or the 10% early withdrawal penalty unless you fail to repay the loan.
- Payment Process - The loan must be repaid monthly, within five years. With ReservePlus, you'll receive a monthly statement and invoice in the mail. You can make your payments by check or with automated ACH transfers from your bank account.
- Payment in Full - You can always repay your loan in full at any time with no penalties.
- Consents - With some 401(k) plans, you'll be required to obtain the consent of your spouse (if applicable) before you can obtain a loan. It's also important to keep in mind that, just because you can obtain a loan from your plan, it doesn't mean it's always appropriate. Therefore, carefully consider the pros and cons listed below before taking a loan. And remember, the purpose of a 401(k) plan is to fund your retirement, so don't shortchange your golden years by treating it as a checking account.
- You can save for a secure retirement with the confidence of knowing that you have access to your money should the need arise.
- It's convenient. There is no credit check or credit application form.
- The interest rate is typically lower that the rate charged for unsecured loans.
- Most plans allow you to borrow for any reason, but check your plan's Loan Policy Statement for any restrictions.
- The interest you pay back to your 401(k) plan is returned to you and it's tax-sheltered. You pay no taxes on the interest until retirement, when you take money out of the plan.
- You select which investments in your plan account you'll sell to obtain the funds for your loan and leave those investments with the best performance.
- There are "opportunity" costs. According to the U.S. General Accounting Office, the interest rate you pay yourself on your plan loan is sometimes less than the returns your plan investments.
- Smaller contributions. Because you now have a loan payment, you may be tempted to reduce the amount you are contributing to the plan and thus reduce your retirement nest egg.
- Loan defaults can be harmful to your financial health. If you can't repay the loan, it is considered defaulted. Should this occur, the outstanding loan balance will be taxed as current income and you'll incur an early withdrawal penalty of 10% if you are not at least age 59?.
- Interest on the loan is not tax deductible, even if you borrow to purchase a primary residence.
- There may be fees involved. There could be a onetime loan setup and activation charge usually ranging from $25 to $250.
- Are nearing retirement.
- Can obtain the funds from other sources at lower interest rates.
- Anticipate you may not be able to continue to make regular contributions to your plan.
- Need the loan to meet everyday living expenses.
What are some of the most common reasons people take out a 401(k) loan?
The most common reasons of a plan loan are to pay for:
- College tuition costs.
- Uninsured medical expenses.
- The purchase of a primary residence.
- Rent or mortgage payments to prevent being evicted or defaulting on a mortgage.
If you quit working or change employers most plans require the full repayment of a loan within 60 days of termination of employment. However, with the ReservePlus loan program, you have up to five years to pay off your loan, regardless if your employment status changes, as long as you continue to make your required loan payments.
Will a 401(k) loan appear on my credit report?
Loans from your 401(k) are not reported to credit-reporting agencies. But if you are applying for a mortgage, lenders will ask you if you have such loans and they will consider the loans as debt.
If I default on my loan, will the default be reported to credit reporting agencies?
If you default on a 401(k) loan, the default will not be reported to credit reporting agencies and it will not negatively affect your credit rating.
If I can't afford to keep making the payments on my loan, can I stop them?
Once the loan has been made, your payments must continue until the loan is paid off in order to avoid immediate taxation and possible early withdrawal penalties.
If I default on my loan, how will I know the amount I must report as income on my federal tax return?
You will receive a Form 1099-R from the plan which will show you the exact amount to report. This amount will also be provided to the IRS.
I still have a 401(k) account at a former employer. Can I get a loan from this old 401(k)?
Plans are not required to let former employees take loans and few allow them to do so.
How do I apply for a ReservePlus loan?
Talk to your Human Resources department to obtain a ReservePlus loan kit.
How do I initiate a ReservePlus loan?
To access your money, simply use the ReservePlus Loan Card, which is similar to a debit card, at thousands of ATMs and merchants across the country. You can also initiate a loan using ReservePlus checks. It is only when you initiate a transaction that a loan is created. This way, you borrow only what you need, when you need it most.
How do I increase my ReservePlus loan line?
Please log on to your plan website or contact your Plan Administrator to determine your eligibility and/or request a loan line increase.
How do I decrease my loan line?
Call Customer Service at 1-800-346-8380. In order to process your request, your outstanding balance must be below the lower loan limit you are requesting. You will receive a confirmation in the mail that your line has been decreased once the request has been processed.
Can I convert an existing (traditional) 401(k) loan into a ReservePlus loan?
Please contact your Plan Administrator for details.
Where can I learn more about how my specific plan handles 401(k) loans?
Talk to your plan administrator or ask them for a copy of your plan's Summary Plan Description (SPD). The SPD will spell out exactly why and how you can obtain a loan from your 401(k).
Where can I learn more about 401(k) loans and plans?
For more information on 401(k) loans as well as general 401(k) information, visit 401khelpcenter.com at www.401khelpcenter.com.
