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401k Plan Loans - An Overview

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Allowing loans within a 401k plan is allowed by law, but an employer is not required to do so. Many small business just can't afford the high cost of adding this feature to their plan. Even so, loans are a feature of most 401k plans. If offered, an employer must adhere to some very strict and detailed guidelines on making and administering them.

The statutes governing plan loans place no specific restrictions on what the need or use will be for loans, except that the loans must be reasonably available to all participants. But an employer can restrict the reasons for loans. Many only allow them for the following reasons: (1) to pay education expenses for yourself, spouse, or child; (2) to prevent eviction from your home; (3) to pay un-reimbursed medical expenses; or (4) to buy a first-time residence. The loan must be paid back over five years, although this can be extended for a home purchase.


Usually the participant is allowed to borrow up to 50% of their vested account balance to a maximum of $50,000 (set by law). Because of the cost, many plans will also set a minimum amount and restrict the number of loans any participant may have outstanding at any one time.

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Loan payments are generally be deducted from payroll checks and, if the participant is married, they may need their spouse's to consent to the loan.

Funds obtains from a loan are not subject to income tax or the 10% early withdrawal penalty. If the participant should terminate employment, often any unpaid loan will be distributed to them as income. The amount will then be subject to income tax and may also be subject to 10% withdrawal penalty. A loan can't be rollover into an IRA.

There are generally four reasons given to avoid 401k loans if possible:

* Lower investment return. According to the General Accounting Office, the interest rate you pay yourself on your plan loan is often less than the rate your ......


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