A 401(k) is the most common type of retirement plan offered by private-sector employers, and many of these plans offer the ability to take out a loan against the assets in your plan. However, this can be challenging to do once you no longer work for the employer sponsoring the plan. Here's what you need to know about post-employment 401(k) loans, and other options that may be available.
The short answer
Most, if not all, 401(k) plans do not allow former employees to take out loans from their accounts, and actually require that any previously outstanding loans be paid back within a short period of time after leaving employment.
It's easy to understand why -- after all, while you're receiving paychecks, the "lender" is guaranteed that you'll repay your 401(k) loan as agreed. Once you're no longer receiving those paychecks, you become much more of a credit risk. In fact, about 10% of borrowers default on 401(k) loans, primarily because of a job change.
While you're technically borrowing the money from yourself, there are still legal reasons why you need to pay it back. Specifically, the tax benefits you get with a 401(k) are based on the assumption that you'll leave the money alone until you retire. If you fail to pay back a 401(k) loan, it's considered to be a distribution, and you'll face the same taxes and penalties as if you simply withdrew money.
In short -- 401(k) loans are generally made exclusively to current employees.
Alternative methods of accessing your 401(k) funds
While you can't directly take out a loan from your old employer's 401(k), there may be other ways of borrowing or accessing your money without facing a penalty.
- If you have a new job with a 401(k), consider rolling over the money into your new employer's plan and then taking a loan. Keep in mind that not all employers will allow this, and those that do are likely to have a certain waiting period, but it's worth looking into.
- Certain types of 401(k) withdrawals are exempt from the 10% early withdrawal penalty, such as those taken to pay un-reimbursed medical expenses over 10% of your AGI. The IRS has a full list of these exceptions.
- As you can see from the IRS's list, IRA accounts have even more exceptions, such as the ability to withdraw up to $10,000 for a first-time home purchase, or any amount to pay qualified college expenses. If you need the money for one of these things, rolling your account over to a traditional IRA may be a good option.
- Your 401(k) plan might offer hardship distributions under certain specific circumstances, so if you feel like you may qualify, contact the plan's administrator.
- If you're over 55, you can take out your money from a former employer's 401(k) plan for any reason, without penalty. This is known as "separation from service."
- If you need the money on a short-term basis, the IRS allows a 60-day rollover period. In other words, you can withdraw the money in your 401(k) as long as you deposit it in another qualified retirement account within 60 days, giving you penalty- and interest-free access to your money during this window of time. If you need a broker to help you with a rollover, visit our broker center to compare options.
Things to consider
While it may be possible to use your 401(k) funds before you retire; this should still be a last resort or close to it. The money in your retirement accounts is there for that specific purpose, and if you decide to use your retirement savings for other purposes, you could end up regretting it later in life.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors based in the Foolsaurus. Pop on over there to learn more about our Wiki and how you can be involved in helping the world invest, better! If you see any issues with this page, please email us at [email protected]. Thanks -- and Fool on!