If you’re like many Americans, you borrowed from your 401(k) plan during the coronavirus pandemic. The U.S. government actually made it easier to obtain such loans, raising the limits to $100,000 or 100% of your balance vs. the typical limits of $50,000 or 50% of your account value. Now that vaccine distribution is widespread and the economy is reopening, you might be in the position to start paying that loan back. Here are some suggestions for how to pay yourself back in a timely manner and why you should try to return that money to your 401(k) as soon as possible.
Set Up Monthly Withdrawals From Your Paycheck
The easiest and most efficient way to pay back your 401(k) plan is to have your employer take monthly withdrawals from your paycheck. Under this system, you’ll continue to make regular 401(k) contributions like you did before you borrowed against your account, but that money will go toward paying off your loan balance rather than being true contributions. One of the neat features of a 401(k) loan is that you pay back both principal and interest to yourself, so your balance could grow back rapidly if you set up monthly payments. If you can afford it, you might want to make larger contributions than normal so that you’re effectively both paying off your loan and making your normal 401(k) plan contributions.
Make Additional Payments From Your Free Cash Flow
If you get a raise, a tax refund or any other type of “bonus” money, put it toward your 401(k) loan. Although interest rates on 401(k) loans are typically low — and you make interest payments back into your own account — every day that your retirement money isn’t in your account generating interest or capital gains makes it harder for you to reach your retirement savings goals. Consider your 401(k) loan to be a regular liability, like your monthly mortgage, car loan or credit card bills, rather than your retirement account. That could give you the additional incentive you need to start knocking down your 401(k) loan balance in a more aggressive manner.
Think Twice Before Changing Your Job
Typically, if you leave an employer and you have an outstanding 401(k) loan, it becomes due in full immediately. Although it’s up to individual plan sponsors whether or not they want to enforce this type of policy, it is commonplace. In other words, if you take a different job and still owe $50,000 on your 401(k) plan, you should generally expect to either pay your outstanding loan balance back in full right away or treat it as a distribution. As a distribution, you’ll face both a 10% early withdrawal penalty and income tax at your marginal rate. If you have a sizable loan, you might even get kicked up into a higher tax bracket. Additionally, you’ll no longer have that money in your 401(k) plan, which could be devastating for your long-term nest egg. In short, think long and hard before you switch jobs while you still have an outstanding 401(k) loan, unless you have the available cash to pay it back in full.
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Last updated: Aug. 3, 2021