Each 401(k) plan can make its own rules about participant loans, within certain limits. Many allow participants to take multiple loans, as the availability to dip into the funds if needed may encourage more people to use 401(k)s to save for retirement. However, both your individual plan and the Internal Revenue Service may restrict the amount you can borrow.
Read the plan conditions to find out if you can take multiple loans. Even if multiple loans are permitted, you cannot take out more than $50,000 or half the vested balance in loans from any given plan.
Evaluating IRS Guidelines
The IRS mandates that 401(k) participants can’t take out more than $50,000 or half of their vested balance, whichever is lesser, in loans from any given plan from an employer. Loans have to be paid back over a five-year period, unless you’re using the proceeds to buy a home or you’re called up for military service. Loans aren't hardship-based, but ultimately the IRS allows administrators a lot of leeway in how they handle them, as long as the borrowers don't exceed the IRS limits.
Creating Rules for Your Plan
Your individual 401(k) plan makes the decision on handling loans. It can choose not to allow them at all or limit participants to one outstanding loan at a time. Some make you wait a fixed amount of time after one loan is paid off before you can take another one. Many plans do allow more than one loan at a time, so check with yours to see if it falls into that category.
Assessing Borrowing Limits
If your plan does allow for multiple loans, figuring the maximum amount you can borrow isn’t as simple as subtracting your current loan balance from the maximum you’re allowed to borrow. Instead, your maximum loan amount is based on the highest outstanding balance you had on your loans in the previous 12 months. For example, say your plan allows loans up to the IRS maximum, and you have one loan outstanding for $20,000.
If the balance was $35,000 11 months prior, those $15,000 in payments won’t be considered for your loan application. You’ll be allowed to borrow only a maximum of $15,000, or $50,000 minus $35,000.
Exploring Repayment Plans
Some administrators require that you repay your loans via a payroll deduction. If yours doesn’t, you’ll have to make payments according to the administrator’s schedule, but the payments can’t be less frequent than quarterly. Miss those payments, and the amount borrowed can be treated as a distribution, which leads to a 10 percent penalty and additional income tax burdens if you’re younger than 59 1/2.
Should You Take a Loan From a 401(k)?
While a 401(k) loan means you're essentially borrowing from yourself, that does not mean the loan is harmless. On the plus side, it offers access to a pool of funds when you don't have any other borrowing options, for example, when you don't have the credit score to qualify for a personal loan. On the downside, taking a loan or multiple loans from a 401(k) has a significant opportunity cost. You'll miss out on the compound growth that your fund should be making, which means there'll be less cash available at retirement. Assuming you suspend or reduce your contributions for the duration of the loan, you'll miss out on the employer match too.
- Charles Schwab: The Lowdown on 401(k) Loans
- FINRA: 401(k) Loans, Hardship Withdrawals and Other Important Considerations
- IRS. "Retirement Topics - Plan Loans." Accessed Nov. 2, 2020.
- FINRA. "401(k) Loans, Hardship Withdrawals and Other Important Considerations." Accessed Nov. 2, 2020.
- IRS. "Relief for Taxpayers Affected by COVID-19 Who Take Distributions or Loans From Retirement Plans." Accessed Nov. 2, 2020.
- Charles Schwab. "The Charles Schwab Guide to Finances After Fifty: Does It Make Sense to Borrow From My 401(k) if I Need Cash?" Accessed Nov. 2, 2020.
- Maxwell Locke & Ritter. "Options for Your 401(K) Plan at a Former Employer." Accessed Nov. 2, 2020.
- IRS. "Retirement Plans FAQs Regarding Loans." Accessed Nov. 2, 2020.
- The Pension Research Council at the Wharton School. "Financial Literacy: Implications for Retirement Security and the Financial Marketplace: Chapter 4: Financial Literacy and 401(k) Loans," Page 71. Accessed Nov. 2, 2020.
- IRS. "Retirement Topics - Bankruptcy of Employer." Accessed Nov. 2, 2020.