In this article, you’ll learn about 401k plans, including how the structure works and how to take advantage of the loan feature. You’ll also learn about the maximum amount and loan size you can borrow from a plan. Of course, there are plenty of other things you can learn about 401k plans, too. But you can get the basics down in less than 600 characters.
Plan Structure
In less than 600 characters, you can understand the basics of a 401(k) plan. This retirement plan allows employees to make tax-favored contributions to an IRA. The employer makes an annual contribution to the account, up to 25 percent of an employee’s compensation. Participants must be at least 21 years old and earn at least $600 per month to be eligible to participate. They cannot borrow from the account, but they can withdraw it, subject to penalties in most cases.
A 401(k) plan is an alternative to a traditional pension. In a pension, an employer will set aside money for the employee’s life, and a 401(k) plan allows employees to choose which investments they want to make. Most 401(k) plans offer a selection of stock and bond mutual funds. Many plans also offer target-date funds specifically designed to minimize the risk of investment loss as an employee nears retirement.
Loan Feature
When you need to borrow money fast, you can use the 401(k) plan loan feature. Again, the process is quick and easy. No credit check is required. And since your loan is from a retirement account, it won’t affect your credit score. Typically, you can repay the loan in five years with no penalty. Moreover, most plans allow you to make payments by payroll deductions, which means you will be paying the money back with after-tax dollars.
Plan Maximum Amount
You’re not alone if you’re wondering how much you can contribute to your 401k plan. The Internal Revenue Service has set limits on 401(k) contributions. The maximum contribution for individuals under age 50 is $18,000 per year, while those aged 50 and older can contribute up to $24,000 per year. Employers can also contribute up to $54,000 annually to their employees’ accounts.
Your maximum contribution to a 401(k) plan depends on your compensation. Contributions must be no more than 25% of your compensation. However, catch-up contributions are allowed. You cannot contribute more than the maximum amount in a single year.
Loan Size
The loan amount depends on the participant’s age, gender, and income. While younger people have a smaller risk of defaulting on the loan, older workers face a higher risk of default.
The median new loan amount is $5,600. However, total loans varied from $1,555 at the 10th percentile to $32,124 at the 90th percentile. The median total loan was 40 percent of a worker’s plan balance. The more loans a person took, the greater the risk of default.
Loan Defaults
A 401k plan loan default occurs when the loan is not paid back within the specified time. This time frame may differ between plans. Most require repayment to be made through payroll deduction. If you miss a payment, you usually have 60 days to make up the difference before you are penalized for non-payment.
Generally, 401(k) plan loan limits are fifty percent of the account balance or $50,000. In addition, the interest rate is lower than the rate you would have received had you withdrawn the funds from your plan. As a result, you may often have to reduce your contributions to make the payments, which will reduce your long-term retirement account balance. Loan defaults can be devastating to your finances. You may have to pay taxes on the unpaid balance, and in some cases, you may face an early withdrawal penalty.
The average age of participants who took 401(k) loans was thirty-five to forty-four. The number of individuals taking plan loans decreased among employees aged 45 and older. Although workers sixty-five and older paid no penalty on their plan loans, the risk of default was not reduced. A borrower’s rate of return after a plan loan default is based on their portfolio allocation and other factors. A 401(k) loan may be an optimal solution if the borrower has a low income and is liquid-constrained.