When money’s tight, borrowing from your 401(k) might seem like a quick fix. The IRS allows participants to borrow up to the lesser of $50,000 or 50% of their vested account balance for pressing financial needs such as medical emergencies, home repairs, bills, and more.
While borrowing from your 401(k) can be a quick way to get cash without paying taxes or penalties, it’s not always the best option for people in the workforce due to the volatility of the job market.
Obtaining a 401(k) loan is usually easier than going through a financial institution for a home equity or personal loan, but the interest rate can be one or two points higher than the prime rate, making an already sticky financial situation, even stickier.
Things get even more complicated if you change jobs or face unexpected job loss. Leaving your employer while carrying a 401(k) loan means you’ll need to repay the full outstanding balance by the due date of your next federal tax return.
Read on to learn what happens to a 401(k) loan when you leave a job to learn how to navigate the situation.
What Happens if I Leave My Job with a 401(k) Loan?
If you find yourself packing your desk, make sure you understand the rules and regulations for 401(k) loans before you leave. The IRS requires people with outstanding balances to repay the borrowed amount in full by the next federal tax return due date, or else penalties will occur.
According to Beagle, if you are unable to pay the amount back by the due date, then you will have to pay income tax on the borrowed amount, including a 10% early withdrawal penalty if you are below the retirement age of 59½. This can cause additional financial strain, especially if you’ve already spent the entire amount you borrowed.
Let’s break it down: if you borrowed $50,000 in August and haven’t made any payments toward the loan since, then you will owe $50,000 by April 15 the following year.
In tight financial situations, people may find themselves needing additional loans to pay back their 401(k)-loan balance, which can create a bigger problem over time.
If you find yourself in a position where you’re leaving a company – whether forced or by choice – check with the company’s benefits specialist to understand the timeframe you have to make payments on the borrowed amount. CNBC reports that most companies won’t let you make payments once your position is terminated, but it’s worth checking.
Ways to Pay Off a 401(k) Loan
If you need to brainstorm ways to pay back your balance, look no further. There are a variety of ways you can here are a few ways to speed up repayment:
- Round Up Payments: If your budget allows, round up your 401(k) loan payments every month to the nearest $100 dollars. If you’re paying $550 per month, round up to $600. You will zero out your balance a lot faster, with little to no sacrifice on your part. If you need to make room in your budget, use the 50/30/20 rule to adjust your spending and savings as needed. If you haven’t created a monthly budget yet, read our guide to creating a budget for pointers.
- Get a Side Gig: Driving for Uber, delivering groceries with Shipt, or working as a freelancer can help you generate extra income outside your 9–5. Every dollar earned on the side can go directly toward your loan without disrupting your monthly bills. By making extra income in your free time, you can pay your 401(k)-loan balance off quickly.
- Make Extra Payments:Tax refund coming? Unexpected bonus? Got some tip money from a side hustle? Put it toward your 401(k) loan. Even small extra payments can help you get out of debt faster and save on interest.
Understand the Rules and Risks
401(k) loans can be a good option in a pinch, but be sure to have a solid plan to pay it back quickly. Finding yourself in a position to pay off extra debt without a solid income can cause additional financial strain, so make sure you understand the rules and regulations before you start withdrawing funds. And if you’re considering a job switch or sense instability in your current role, it may be better to explore other financial options.
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