You're allowed to take money out of your 401(k) plan only if you're over age 59 1/2, have left the company or have a severe financial hardship. Hardships are defined by your 401(k) plan and can include distributions necessary to prevent a bank from foreclosing on your primary residence. However, these distributions are subject to income taxes and a 10 percent early withdrawal penalty if you're under 59 1/2. Hardship distributions are available only when you're facing foreclosure, not when you simply want to pay off your home early.
401(k) Loan Options
Your 401(k) plan may allow you to take a loan from your account for any reason, including paying off your mortgage. You can borrow up to $50,000 or half your account balance, whichever is smaller. For example, if you have $40,000 in your 401(k) plan, you can borrow up to $20,000. Loans are repaid through reductions in your future paychecks and must be repaid over five years in most cases. However, if you leave the company, the entire balance is due immediately.
Pros and Cons
The interest you pay on the 401(k) loan gets credited to your 401(k) account balance, so it's like you're paying yourself interest. And, there's no credit check because you're borrowing your own money. However, the loan could be due immediately if you change jobs or get fired, leaving you in a tight spot financially. In addition, even though you're paying yourself interest, those amounts could be less than the return you would have made if your money was invested in the stock market or bond funds. You must weigh the pros and cons as they apply to your circumstances. There's no one right answer for everyone.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."