Each 401(k) plan varies, and they come with their own set of restrictions and rules regarding loans. It is ideal to consult your employer or ask the human resources manager about how your particular plan is typically managed and what are the terms and conditions regarding short-term lending. However, mentioned here are some basic terms commonly used for several 401(k) loan programs that can help:
1. Minimum loan allowance
The 401(k) accounts and programs come with a minimum loan amount specified, and it is typically around $1,000. These minimum loan allowances differ based on which plan the company has enrolled its employees in, and this limit also ensures that employees’ savings discipline is kept in check.
2. Repayment term
The repayment term is nothing but the duration through which the borrower would repay the loan. A personal loan made against a 401(k) loan comes with a maximum repayment term of five years. While some programs permit extended home loans, the borrower may have to face restrictive repayment terms in such a case.
3. Maximum loan limit
The maximum loan limit refers to the maximum amount that can be borrowed against a 401(k). Typically, these loans are restricted to not more than 50% of the vested balance in the fund, and the amount should not be more than $50,000. In most cases, one would only be able to withdraw from their own contribution to the 401(k) and not from the funds contributed by the employer.
4. Repayment structure
The repayment structure on each loan differs, and it refers to how the borrower can return the money they borrowed. With certain exceptions, the repayment of 401(k) loans is through deductions from their paycheck in the form of installments equating to the borrowed amount until the balance is completely paid off. In addition, these deductions are over and above the regular contributions to the account.
5. Taxable proceeds
Taxable proceeds are another crucial term associated with understanding 401(k) loan basics. The proceeds from a 401(k) loan are exempted from tax. However, if one is unable to pay off their loans in full and on time, they would need to pay the taxes on the full amount.
6. Interest rate
Another 401(k) loan basics term is the interest rate on the loan, which gets evaluated at a certain rate. This particular interest rate is set at a current prime rate with 1% added to it.
7. Additional fees
Much like the interest rate, there are other additional fees associated with a 401(k) loan. These can include the processing fees of the loan and the yearly fees, among others.
Once you think of borrowing from your 401(k), these are the terms that you would need to keep in mind to ensure that you are reading everything between the lines. They are the most crucial 401(k) loan basics that can help you navigate tricky waters.