What is a 401k Loan?

Ideally, everyone would have a savings account or emergency fund to draw on when they face unplanned expenses. But in the real world, it’s common for cash flow to fall short of one’s needs from time-to-time. For many people, their largest financial asset is their retirement savings in a 401k account.

To help individuals manage the challenge of both saving enough for retirement and setting aside money for unplanned expenses, most 401k plans allow the business owner and employees to take loans from their 401k accounts. When the 401k loan is repaid to the plan account, with interest, an individual can stay on track with their retirement savings even while addressing short-term cash needs. But loans that are not repaid can put retirement savings at risk.

401k Loan Rules

Maximum 401k loan

The maximum amount that you may take as a 401k loan is generally 50% of your vested account balance, or $50,000, whichever is less. If 50% of your vested account balance is less than $10,000, you may borrow up to $10,000 if your plan allows it.

Loan administration

All 401k plan loans must meet the following requirements:

• Each loan must be established under a written loan agreement.
• The business owner must set a commercially reasonable interest rate for plan loans.
• A loan cannot exceed the maximum permitted amount.
• A loan must be repaid within a five-year term (unless used for the purchase of a principal residence).
• Loan repayments must be made at least quarterly and in substantially equal payments that include principal and interest.

The business owner has some flexibility in designing a loan program for their 401k. For example, they may choose to set a limit on the number of loans an employee may take at one time or within one year or set a minimum dollar amount for a loan.