401k loans are a bad choice. I have borrowed from my 401k, and it was a mistake. I wish I hadn’t done it. It was years ago. My 401k had just reached $6000. I was able to borrow half. So I borrow $3000. I intended to use it towards our wedding and honeymoon. I think I ended up piddling much of it away. I repaid the load over the next year or two. But meanwhile my 401k continued to rise. If I had had that $3000 in my 401k working for me, I would have had more money in the long run. My 401k is currently worht about $250,000. But if I hadn’t borrowed that $3000 in those early days, how much more would I have had? 401k loans are a bad idea!

But, sometimes you HAVE to have the money. 401k loans are an option if you are unable to get money elsewhere.
Employers may have limits. They may require you to have a minimum balance before you can take 401k loans. You might only be able to borrow a portion of the money you have in your 401k. If you do take 401k loans, You will have to pay the money back over a certain period of time. If you default on the loan, the IRS will consider it a withdrawl, and you will have to pay taxes and penalties on the money.

Besides 401k loans, there other cases where you can withdraw money from your 401k plan without penalties. You will still probably have to pay taxes on the money however: Here is what the IRS website says:

Hardship distributions. A 401k plan may allow you to receive a hardship distribution because of an immediate and heavy financial need. Hardship distributions from a 401k plan are limited to the amount of the employee’s elective deferrals and generally do not include any income earned on the deferred amounts. If the plan permits, certain employer matching contributions and employer discretionary contributions may also be included in hardship distributions. Hardship distributions cannot be rolled over to another plan or IRA.

A distribution is treated as a hardship distribution only if it is made on account of the hardship. For purposes of this rule, a distribution is made on account of hardship only if the distribution is made both on account of an immediate and heavy financial need of the employee and is necessary to satisfy that financial need. The determination of the existence of an immediate and heavy financial need and of the amount necessary to meet the need must be made in accordance with nondiscriminatory and objective standards set forth in the plan.

A distribution on account of hardship must be limited to the distributable amount. The distributable amount is equal to your total elective deferrals as of the date of distribution, reduced by the amount of previous distributions of elective contributions.

Immediate and heavy financial need.  Whether an employee has an immediate and heavy financial need is to be determined based on all relevant facts and circumstances. A distribution made to an employee for the purchase of a boat or television would generally not constitute a distribution made on account of an immediate and heavy financial need. A financial need may be immediate and heavy even if it was reasonably foreseeable or voluntarily incurred by the employee.

A distribution is deemed to be on account of an immediate and heavy financial need of the employee if the distribution is for:

  • Expenses for medical care previously incurred by the employee, the employee’s spouse, or any dependents of the employee or necessary for these persons to obtain medical care;
  • Costs directly related to the purchase of a principal residence for the employee (excluding mortgage payments);
  • Payment of tuition, related educational fees, and room and board expenses, for the next 12 months of postsecondary education for the employee, or the employee’s spouse, children, or dependents; or
  • Payments necessary to prevent the eviction of the employee from the employee’s principal residence or foreclosure on the mortgage on that residence.

Note: The final 401k regulations were published in December 2004 and apply for plan years beginning on or after January 1, 2006. However, plan sponsors are permitted to apply these final regulations in the current plan year. Check with your plan administrator to see if your plan has been amended to apply the new hardship rules provided for under the final regulations.

The final regulations add the following expenses to those deemed to be immediate and heavy financial needs:

  • Funeral expenses
  • Certain expenses relating to the repair of damage to the employee’s principal residence.

Distribution necessary to satisfy financial need. A distribution may not be treated as necessary to satisfy an immediate and heavy financial need of an employee to the extent the amount of the distribution is in excess of the amount required to relieve the financial need or to the extent the need may be satisfied from other resources that are reasonably available to the employee.

This determination generally is to be made on the basis of all relevant facts and circumstances. The employee’s resources are deemed to include those assets of the employee’s spouse and minor children that are reasonably available to the employee. Thus, for example, a vacation home owned by the employee and the employee’s spouse, whether as community property, joint tenants, tenants by the entirety, or tenants in common, generally will be deemed a resource of the employee. The amount of an immediate and heavy financial need may include any amounts necessary to pay any federal, state, or local income taxes or penalties reasonably anticipated to result from the distribution.

An immediate and heavy financial need generally may be treated as not capable of being relieved from other resources reasonably available to the employee if the employer relies upon the employee’s written representation, unless the employer has actual knowledge to the contrary, that the need cannot reasonably be relieved:

  • Through reimbursement or compensation by insurance or otherwise;
  • By liquidation of the employee’s assets;
  • By cessation of elective contributions or employee contributions under the plan; or
  • By other distributions or nontaxable (at the time of the loan) loans from plans maintained by the employer or by any other employer, or by borrowing from commercial sources on reasonable commercial terms in an amount sufficient to satisfy the need.

A need cannot reasonably be relieved by one of the actions listed above if the effect would be to increase the amount of the need. For example, the need for funds to purchase a principal residence cannot reasonably be relieved by a plan loan if the loan would disqualify the employee from obtaining other necessary financing.

A distribution is deemed necessary to satisfy an immediate and heavy financial need of an employee if all of the following requirements are satisfied:

  • The distribution is not in excess of the amount of the immediate and heavy financial need of the employee.
  • The employee has obtained all distributions, other than hardship distributions, and all nontaxable (at the time of the loan) loans currently available under all plans maintained by the employer.
  • The employee is prohibited, under the terms of the plan or an otherwise legally enforceable agreement, from making elective contributions and employee contributions to the plan and all other plans maintained by the employer for at least 6 months after receipt of the hardship distribution.

But please heed my advice! Avoid 401k loans! Don’t make the same mistake I did.