Ten Guidelines for 401(k) Loans

By Joné E. Liuzza, ERPA, QPA, QKA

Joné E. Liuzza, ERPA, QPA, QKA

Joné E. Liuzza, ERPA, QPA, QKA Director of TPA Services

 If your 401(k) plan allows participant loans, here are 10 rules that will keep you out of trouble and in good graces with the IRS and Department of Labor:


  1. The maximum loan amount is the lesser of 50% of your vested account balance or $50,000. If your plan allows you to have more than one loan, the limit applies to all loans collectively.
  2. You must complete loan documentation which includes loan amount, interest rate, payment frequency and maturity date. Plan sponsors should maintain all loan records in case plan is chosen for an audit.
  3. Loans must be repaid in substantially level payments at least quarterly.
  4. The maximum term for your loan is five years. A longer term is permitted for a loan used to acquire a primary residence.
  5. Loan payments are typically paid through payroll deduction. Consider how payments will be made if you do not receive a regular paycheck. There may not be anyone to remind you to make your payments on time.
  6. Plans do not have to permit loans, but if they are permitted they must generally be available to all participants. If Highly Compensated Employees are allowed to take loans, Non-Highly Compensated Employees must also be allowed to take loans.
  7. Loan interest must be reasonable and comparable to what banks are charging for similar loans. The prime rate plus one or two percentage points have been industry standard for the past several years. (Note that the IRS has not blessed the use of such a benchmark.)
  8. If a participant terminates employment, the loan balance will generally be deemed a distribution and taxes will be owed on the outstanding balance. A loan in default could be subject to an early distribution excise tax of 10% on top of the income taxes.
  9. If a loan payment is missed and not made up within a grace period, the loan will be in default and subject to immediate taxation. An IRS correction program is available in limited circumstances.
  10. Check with your plan sponsor for specific plan provisions. There may be fees involved, a plan loan minimum or a limit on the money types eligible for loans.

This is not a comprehensive list of 401(k) loan rules. We invite you to contact us at (804) 323-1886 with questions about best practices for plan loans and retirement plan administration.

— Topics: 401(k), Retirement