What Happens to Your 401 (K) Loan If You Get Fired?
Taking a loan from your 401 (k) is one of those financial rafts that we at Lifehacker only recommend in case of despair. But if you are already thinking about taking out one of these loans, you probably think that you are already in the worst financial scenario. You may not be thinking about what could get worse: if you lose your job.
Whether you leave of your own accord, get fired as a result of a restructuring, or get fired right away, you will have to pay back this loan, even if it is your own money. And you need to do this pretty quickly.
How 401 (k) loans work
To quickly recap: The IRS allows you to borrow from your 401 (k). Loans can start from $ 10,000 or from half of your personal account balance (money that you own, which can vary depending on your company’s retirement plan).
You cannot borrow more than $ 50,000. In fact, you can take out multiple loans from your 401 (k) as long as the total amount of your new and old loans does not exceed the limits stated above.
You immediately start repaying the loan, and usually you have to pay back every penny you borrowed within five years. (The term may be longer if you are using the loan to buy a home).
The advantage of a 401 (k) loan is that since you are borrowing money from yourself, you can access cash without a credit check.
Why taking out a 401 (k) loan is risky
The downside is that you stick your hand into the cookie jar that you shouldn’t touch until you retire. You will really need this cookie right now for the loan to pay off.
Job change is another major disadvantage of getting a loan from 401 (k). If you get fired, fired, or decide it’s time to leave, you’ll be hooked on the amount you borrowed, even if it’s your own money.
A typical 401 (k) loan has a payback period of five years. But according to the Bureau of Labor Statistics, the average tenure of employees is 4.2 years. Thus, half of people quit their jobs in less than 4.2 years. If this is you and you have a 401 (k) loan, you will have to deal with the consequences.
If you cannot repay the loan, it counts as an allocation, is reported as income, and you will have to pay a withdrawal penalty in excess of income tax.
Another option is to transfer the loan to another eligible retirement account. IRAs do not offer such loans, so you will have to transfer your account to another 401 (k), 403 (b) or 457 (b) account.
The repayment terms have been relaxed, but we still don’t like these loans.
You do have a little more time to correct the situation than before. Prior to the Tax Cuts and Employment Act of 2017, you had to repay your 401 (k) loan within 60 or 90 days if you quit your job. But now you have until Tax Day the year you quit your job.
If you took out a 401 (k) loan in 2018 and quit your job today, for example, you have time until you file your 2020 tax return in April 2021 (or October 2021 if you get an extension). to pay off your balance. …
This means that if you quit your job and get a new one within a few months, you may have time to take care of the renewal process – or pay off the loan in full – by April 15th.
If you are lucky, like in our example, you will have almost a year to put everything together. If you take out a loan in the fall and then get the bank right before Christmas, well, you won’t have too much planning time.
This is why a 401 (k) loan should always be a last resort . If you do not think that you will be working for your company for the rest of your career, you should think carefully about the possible consequences before taking any action.