Every company's 401(k) plan is different, but most companies allow workers to borrow money from their 401(k) for just about any purpose, including car purchases. There are, however, some rules the Internal Revenue Service has set that must be followed when an employee borrows money from a 401(k). The good news is there is normally no credit check.
How Much Can You Borrow?
The IRS limits loans from 401(k)s to a maximum of 50 percent of the vested account balance or $50,000, whichever is less. Uncle Sam makes an exception for workers if 50 percent of their vested amount is less than $10,000. In those cases, IRS rules allow the employee to borrow up to $10,000. Companies set their own guidelines for the workplace retirement accounts, however, and they are not required to include this exception.
You may get better loan terms borrowing from your 401(k) than you would get at a bank or car dealership. With a 401(k) loan, you'll pay the prime interest rate plus one or two percentage points. The prime interest rate is the rate banks charge their very best customers. The good news is you are paying the principal and interest back to your own retirement account over a maximum period of five years. The bad news is that while your money is not invested, it's not earning for you and you could miss a big upward swing in the market.
Unless you plan to buy a car costing $5,000 or less, you may need your spouse's approval to borrow money from your 401(k). Some plans require it. Others don't require a worker's spouse to approve a loan of any amount. The IRS doesn't take sides. The federal agency leaves it up to individual companies to set their own guidelines regarding spouses and 401(k) loans.
Leaving the Job
If you leave the job for whatever reason before the 401(k) loan is repaid, you'll get to keep the car, but you'll have to settle the entire 401(k) debt within 60 days. If you can't pay the loan off, whatever you owe will be treated as a withdrawal from the 401(k), which means you will owe taxes on the outstanding loan balance and a 10 percent early withdrawal penalty if you're younger than 59 1/2 in the year that you leave the job.
Tim Grant has been a journalist since 1989 and has worked for several daily newspapers, including the Charleston "Post & Courier," the "Savannah News-Press," the "Spartanburg Herald-Journal," the "St. Petersburg Times" and the "Pittsburgh Post-Gazette." He has covered a variety of subjects and beats, including crime, government, education, religion and business. He graduated from The Citadel with a Bachelor of Science in business administration.