A 401(k) plan is a way for employees to save for retirement. Many private-sector employers offer this type of retirement vehicle to their workers. The 401(k) plan offers several benefits to employees, including the possibility of borrowing from their retirement plan in certain circumstances. If you are no longer working with an employer, the situation becomes more complicated.
Borrow From a 401(k): The Basics
If the plan allows members to borrow from their 401(k), they can take out a loan up to $50,000 or 50 percent of their assets, whichever amount is lower. With this type of loan, you do not apply to a lender for funding. There are no credit checks required. In essence, you are borrowing the money from yourself, tax-free.
You repay the amount with interest. All of the money paid back goes into your retirement account. Keep in mind that while you are paying off the loan, you will not be making interest on the money borrowed in your retirement account. Consider this tradeoff very carefully before taking out the loan.
401(k) Loan From Previous Employer
Getting a 401(k) loan from a previous employer is unlikely. Most plans do not allow former employees to borrow from their previous employer’s 401(k) plan. The reason is simple: Generally, an employee makes 401(k) loan payments from their paycheck. Once the employer-employee relationship stops, there is no easy way for the loan payments to continue.
The usual repayment term is five years. Once an employee leaves an employer, most 401(k) plans state that outstanding loans need to be dealt with quickly. The loan repayment schedule is accelerated since a former employee is considered a higher credit risk.
Read more: Can I Borrow With My 401(k) as Collateral?
Options for Accessing Work Retirement Investments
You still have options if you want to borrow from your 401(k) plan after leaving your employer.
Roll Funds into New Employer’s Plan, Then Borrow
More than half of 401(k) plans allow new members to transfer funds directly from an existing retirement plan. You can apply to borrow from your retirement plan through the new employer’s 401(k).
Set up an Individual Retirement Account
If you want to be in charge of your investment options, including having more choices about withdrawing the funds, you may want to consider an individual retirement account (IRA). You can invest your money in several types of investment accounts, such as stocks, bonds and mutual funds, if you wish. Keep in mind that if you decide to withdraw funds, they will be subject to withholding tax.
Just Cash Out Your Old 401(k)
You can choose to cash in your retirement plan. However, this option is the one that could have direct consequences for you at tax time. The good news is that you can use the money for any purpose. The other side of the coin is that you will pay withholding tax immediately. You will have a smaller pool of funds you can draw on during retirement.
Be sure to consider all of them carefully and consult with a tax professional to get advice before making your decision.
Read more: Can I Cash Out my 401(k) After Filing Bankruptcy?
- Expect to pay a 10-percent penalty charge on any outstanding balances you have on a loan you haven't repaid if you lose your job. You have 60 days to repay the loan before being hit with the early-withdrawal penalty. Your job loss can be voluntary or involuntary; it doesn't matter.
- You will be asked to repay the loan in its entirety if you leave a job with an outstanding loan.
Jodee Redmond is a freelance writer, blogger and editor who has been working full-time for over 15 years. She is a graduate of Centennial College and has worked as a tax consultant and a legal assistant. Her previous experience and boundless curiosity is a distinct advantage when writing about such varied topics as income tax, insurance, commercial property, business, construction, addiction, freelance writing and more.