Understanding Individual 401k Loans
One of the most powerful features of an individual 401k is the investor’s ability to take a loan from their own account. The loan can be used to pay down high interest credit cards, take a business line of credit, put a down payment on a house, and many other things. On this page we will discuss how to take a loan out of an individual 401k and what some of the benefits are. To begin, let’s take a look at a short video.
Individual 401k Loan Rules
A. The loan can be borrowed from 0 to 5 years.
B. The loan is amortized so that each month you are paying down principal and interest.
C. You are able to borrow 50% of the value of your individual 401k or $50,000, whichever is less.
D. The interest rate you pay back to your account is generally prime plus 2% (currently about 5%)
IMPORTANT: The interest owed on your loan is paid back into the account. In other words, you are paying YOURSELF back the interest.
The Value of Your Individual 401k During the Loan
The IRS does not consider a personal loan taken from an individual 401k as a distribution, therefore, the account value will remain the same for record keeping purposes. The borrowed amount will be reflected as a note inside of the account. So for example, if you had a $50,000 individual 401k and borrowed $25,000 from it then the account would show a cash position of $25,000 and a note for $25,000.
The Process for Obtaining a Loan from Your Individual 401k
Each exact process will be dependent on whoever the custodian of your account is, but the general procedure is pretty simple. You will fill out a loan application and submit it to your custodian. Then, there will be a few days of processing time while the custodian looks over the application. Finally, once the loan is approved, the loan amount is usually wired or sent by check.
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