Interest-Free 401(k) is relatively easy. Because you’re the lender as well as the borrower, you don’t have to file an application or make your case to some banker. The process at most fund management firms is now largely automatic. You can process your loan online and receive the funds from your 401(k) within days.
But the biggest benefit is that a loan from your 401(k) is mostly interest-free. Any interest you pay will go back to your own fund.
That doesn’t mean that there are no costs in borrowing against your 401(k). The fund will charge you a processing fee, of course. The money that you borrow won’t be generating interest in your fund. You can expect your employer to deduct the repayments directly from your paycheck, after taxes.
More importantly, while you’re repaying your loan, you might not be able to make additional payments to your 401(k). That could cost you a year of contributions, including matching contributions. If your 401(k) fund imposes that restriction, you’ll need to calculate the cost of missing those payments against the amount of interest you would pay for a commercial loan.
And if you leave your job before you’ve repaid the loan, you’ll be at risk of the IRS considering the loan as a distribution. You’ll have to pay tax on the funds and you may also have to pay a withdrawal penalty unless you put the money back in a short amount of time. That deadline used to be either 60 or 90 days after leaving your job. Under the Coronavirus Aid Relief and Economic Security (CARES) Act, you now have up to a year but that might change as the pandemic fades. If that happens, the maximum amount you can borrow is likely to fall back from $100,000 to $50,000.
