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The New Tax Law Makes Repaying a 401(k) Loan a Little Easier

A change in the amount of time to repay a 401(k) loan was included in the Tax Cuts and Jobs Act.  However, there are still complications to be aware of.

Before this change, employees who took a loan from their 401(k) account and then left their employer had only 60 days to repay their loan, or they’d have to pay income taxes on the money plus a 10% penalty, if they left a job before age 55. However, as reported in Kiplinger’s article, “Ex-Workers Get More Time to Repay 401(k) Loans” the new tax law has changed this.

Now, you don’t have to pay taxes or the penalty, if you repay the loan by the due date of your tax return for the year when you leave your job (including extensions).

Therefore, if you leave your job in 2019, you’d have until April 15, 2020, to repay the loan (or October 15, 2020, if you file an extension).

However, using the extended time frame to repay could lead to complications, if you’d like to roll over your 401(k) balance to a new employer’s plan.

You can generally borrow up to 50% of your 401(k) balance, but no more than $50,000.

Most plans charge the prime rate plus 1% point for the loan. As of February, that would add up to 6.50%.

You typically have five years to pay back the loan, while you’re still working for that employer or longer if the 401(k) loan is to buy your primary residence. Most plans give employees 10 to 15 years to repay a loan for a primary residence, but some plans have deadlines as short as five years or as long as 30 years.

If you do take a 401(k) loan, try to keep contributing to your 401(k), while you’re paying back the loan. That way you can continue to get any employer match and to minimize the hit to your long-term savings.

You borrow your own money and pay the interest back into your account. However, you’ll lose the opportunity for investment gains on the borrowed money, while it’s out of the account.

A word of caution: taking a 401(k) loan makes it even more important than ever to have an emergency fund and save enough in a company-sponsored plan to receive an employer match. Financial discipline is like a muscle—use it, and it will grow, along with account balances.

Reference: Kiplinger (February 13, 2019) “Ex-Workers Get More Time to Repay 401(k) Loans”

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