Financial conditions are indeed unpredictable; there will be times when you have more and there will be times when you have less. Even though you may be enrolled in one of the retirement plans, you cannot freely withdraw the funds. As the name implies, retirement savings can only be cashed after you actually retire from your job.
So, what if you need emergency funds? This is good news if you have a 401(k) plan. Well, this plan allows you to take a loan and repay it at the appointed time. But sometimes, you may not want your employers to know if you take a 401(k) loan.
The question is whether or not your employer will know if you take a loan from a 401(k) plan. Now, you can learn more about a 401(k) plan and guidance for making loans from the retirement plan in our post below.
What is a 401(k) Plan?
A 401(k) is a retirement savings account provided by an employer to their employees. It is called a 401(k) since it was created under a section of the U.S. Internal Revenue Code. These savings come from salary deductions, which are deposited into the account on a pre-tax basis.
Unlike other plans that require you to pay taxes and only save a portion of your salary, a 401(k) actually allows you to invest every dollar you earn through these savings. That’s why it is considered a retirement savings plan that gives tax advantages to savers.
There are two types of a 401(k) plan, including:
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- A Traditional 401(k): This type allows the contributions of employees to be pre-tax. That means their contribution is not taxable, but it will be taxed when the funds are withdrawn upon retirement.
- A Roth 401(k): This type allows the contributions of employees to be made with after-tax income. That means their contributions will be taxed, but when the funds are withdrawn, they’re not taxed.
Can You Take a Loan from a 401(k) Plan?
Sure, you can.
In fact, a 401(k) plan is one of the best retirement plans since it allows you to take out a loan. So, it can help you when you need urgent funds.
Since a 401(k) is tax-free and should be withdrawn when you retire, you can still take a loan from it by paying the proper taxes on your earnings plus a 10% early withdrawal penalty.
Keep in mind that it is not an upfront withdrawal but a loan, meaning you need to pay this money back into your 401(k) plan. The IRS typically gives borrowers five years to pay back the loan, unless the funds are used to purchase their primary home. Sure, you’ll have more time to pay it back.
If you pay the loan regularly and on time, you shouldn’t pay taxes or penalties on the loan. But if you fail to repay the loan, you’ll be required to pay taxes and penalties on the money you borrowed.
Should You Take Out a 401(k) Loan?
It depends on your needs.
Taking out a 401(k) loan shouldn’t happen since anyone can do it, leading to too many loan applications. But it can make sense if you really need emergency funds in the short term. Keep in mind that a 401(k) loan should only be used for emergencies, not for things you don’t really need.
On the other hand, a 401(k) loan is a better alternative for short-term funding than other options, such as advance payday loans or even personal loans. Well, these kinds of loans usually have high interest rates, which will burden the borrower.
If you can, paying off your 401(k) loan early would be better since you will not have to pay a penalty. It can be done by taking regular payroll deductions in increments, allowing you to pay off your 401(k) loan sooner.
Will Your Employers Know If You Take a 401(k) Loan?
Even though the rules for 401(k) loans are not universal and can vary from one employer to another, most employers will be aware of any loans from the plan that they have set up.
It is known that a 401(k) is a retirement savings plan for workers that the employer itself determines when the program is established. And the provisions of 401(k) loans are also regulated by the IRS.
In fact, most employers will appoint an officer or agent to administer a 401(k) program. They’re responsible for monitoring the movement of this program, including the history of contributions, withdrawals, and other aspects. Sure, your employers will have access to every employee record, including loan and emergency fund withdrawals.
But it doesn’t mean that your employers have direct access to this information. However, the data in a 401(k) is still considered confidential financial information. Sure, companies will have specific rules about when and who can see these 401(k) details. In some large companies, for example, only finance or human resources personnel will likely have the right to view these records.
It’s important to note that the loan application will be forwarded to your employer for approval, which will automatically let them know if you’re applying for a 401(k) loan.
Well, it’s best for you to ask an HR official to keep your request confidential if you don’t want your manager or other divisions to know about your loan request.
How to Apply for a 401(k) Loan
To request a 401(k) loan, you may need to contact the human resources (HR) department. Be sure to specify how you will pay your loan back, either by deducting it from your salary or paying it off all at once at a set time.
That way, they can decide:
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- Whether you can take a loan from a 401(k) plan.
- Whether they’ll allow loans only under certain conditions or at any time.
- They can determine what conditions will allow employees to apply for a 401(k) loan.
- They may set a maximum loan amount (up to 50% of the account value).
Even though this loan is not certain to be approved by your employer, be persistent in convincing them.
Pros and Cons of a 401(k) Loan
Even though it is considered the best retirement plan due to the ease of applying for loans, there are still pros and cons at the same time. You really understand that money in your 401(k), but your employers still set the terms and conditions for taking out these loans. They may approve or even prohibit these loans altogether.
Before you apply for a 401(k) loan, it would be better for you to know first what the benefits and drawbacks of this loan are. Here we explain it for you:
Pros
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- This is reliable when you need emergency funds.
- You can avoid paying taxes and penalties since it is not an early withdrawal but a loan that you will pay back.
- The 401(k) loans do not require a credit check, so these debt entries will not appear on your credit report. Even if you fail to pay, it will not be reported to the credit bureaus, so it will not lower your credit score.
Cons
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- There will be less money in your 401(k) savings, so less money will grow in your account. Even if you pay it back, the money still has little time to grow fully.
- You need more time to repay the pre-tax funds in the account.
- Your loan application may not be approved, or the loan amount may not be fully approved. For more information, the maximum loan amount approved is $50,000, or 50% of your account balance.
- You may have to pay taxes and penalties on 401(k) loans.
- A 401(k) loan can turn into a distribution if you don’t repay the loan on time, which means you may have to pay interest, taxes, and penalties on it.
- You will have to pay more quickly if you stop working for your current employer, whether by changing jobs, resigning, or being fired.
After you know both the pros and cons of the 401(k) loan, you can now decide whether you still want to apply for the loan or cancel it. Of course, it’s all your decision.