Retirement plans such as 401(k) and 403(b) plans are not required to offer loans to their participants, so check with your employer’s HR department or with your retirement plan provider to see if you are eligible to take a loan from your retirement account. If a retirement plan does offer loans, it is up to the plan to provide a limit on the amount that can be borrowed. Most plans that offer loans, however, simply apply the maximum limits as defined by the IRS.
The maximum allowable loan from a retirement account as defined by the IRS is as follows:
- The greater of $10,000 or 50% of your vested account balance, or
- $50,000, whichever is less.
Your vested account balance is simply your earned ownership in your retirement account balance. Check with your employer’s HR department or with your retirement plan provider to find out the amount you are vested in your retirement plan account balance. All of this is confusing, so let’s try to break it down with some examples:
Example 1:
You have a 401(k) plan with your current employer and it has an account balance of $30,000.
What is the maximum amount that you can borrow from this plan?
Well, it depends upon your vested amount in the retirement account. Let’s say you check with your HR department and they tell you that you are only 50% vested in your retirement account balance at this time. So, the amount of ownership you have in your retirement plan is $15,000 ($30,000 account balance X 50% vested = $15,000 vested account balance) and the maximum amount that you can borrow in most plans using this scenario is 50% of your vested amount, or $7,500.
Note: Most retirement plan loan limit calculations stop right there. However, according to IRS rule #1 above, the plan may allow up to $10,000 to be borrowed from the plan in this scenario.
Let’s say, on the other hand, that you check with your HR department and they tell you that you are actually 100% vested in your retirement account balance. In this case, the amount of ownership you have in your retirement plan is $20,000 and the maximum amount that you can borrow is 50% of that vested amount, or $10,000.
Example 2:
You have a 401(k) plan with your current employer and it has an account balance of $120,000.
What is the maximum amount that you can borrow from this plan?
Again, it depends upon your vested amount in the retirement account. Let’s say you check with your HR department and they tell you that you are only 50% vested in your retirement account balance at this time. So, the amount of ownership you have in your retirement plan is $60,000 ($120,000 account balance X 50% vested = $60,000 vested account balance) and the maximum amount that you can borrow is 50% of your vested amount, or $30,000.
Let’s say, on the other hand, that you check with your HR department and they tell you that you are actually 100% vested in your retirement account balance. In this case, the amount of ownership you have in your retirement plan is $120,000, but the maximum amount that you can borrow is only $50,000 since the IRS rules state that the maximum amount you can borrow is the lesser of 50% of your vested account balance or $50,000.
The IRS does allow for participants to take multiple loans from their retirement plans, but the rules associated with calculating the maximum amount that can be borrowed in this scenario is complicated and beyond the scope of this post. For more information about multiple loans, review the IRS retirement loans article.
To better understand the potential pitfalls associated with borrowing from your retirement account, check out this related post.
