Fidelity 401(K) Loans: What You Need To Know

Fidelity offers a self-employed 401(k) plan that does not offer a loan provision. However, some 401(k) plans allow loans or hardship distributions, and individuals can borrow from their retirement savings account, which is known as a 401(k) loan. This option has become increasingly popular, with 2.8% of participants taking a loan from their 401(k) in Q3 2023, according to Fidelity Investments' analysis.

Borrowing from a self-employed 401(k)

A self-employed 401(k)—also known as a solo-401(k) or an individual 401(k)—is a retirement savings option for small-business owners with no employees other than their spouse. Self-employed individuals can contribute up to 25% of their net earnings from self-employment, up to a maximum of $69,000 in 2024. These contributions can be made pre-tax, and they grow tax-deferred until withdrawn in retirement.

The Fidelity self-employed 401(k) does not offer a loan provision. However, some other 401(k) plans may allow participants to borrow from their account balance. If you have a different 401(k) plan, you should check with your provider to see if loans are permitted.

Before taking out a loan from your 401(k), there are several important considerations to keep in mind. Firstly, any money you borrow from your 401(k) will miss out on potential investment growth. Secondly, if you leave your job, you may be required to repay the loan in full within a short timeframe. If you default on the loan for any reason, the outstanding balance will be considered a withdrawal, and you may owe taxes and a 10% penalty if you are under 59½ years old. Additionally, you will need to repay the loan with interest, and these payments will be deducted from your paycheck, reducing your take-home pay.

If you are considering a 401(k) loan or withdrawal, it is recommended that you work with a financial professional who can provide a careful analysis of the potential legal, tax, and estate implications.

Pros and cons of 401(k) loans

A 401(k) loan allows you to borrow from your retirement savings account. Depending on your employer's plan, you could borrow up to 50% of your vested account balance or $50,000, whichever is less. You will have to pay back the borrowed money, plus interest, within five years in most cases.

Pros of 401(k) loans

• You don't have to pay taxes and penalties when you take a 401(k) loan, unlike with withdrawals.
• The interest you pay on the loan goes back into your retirement plan account.
• If you miss a payment or default on your loan, it won't impact your credit score because defaulted loans are not reported to credit bureaus.
• You can repay the loan early with no prepayment penalty.
• You don't need to undergo a credit check to borrow from your 401(k).

Cons of 401(k) loans

• If you leave your job, you might have to repay your loan in full very quickly.
• If you can't repay the loan for any reason, it's considered defaulted, and you'll owe both taxes and a 10% penalty on the outstanding balance if you're under 59 and a half years old.
• You lose out on investing the money you borrow in a tax-advantaged account, so you miss out on potential growth that could exceed the interest you pay yourself.
• Your take-home pay will be reduced as loan repayments are typically deducted from your paycheck.

Hardship withdrawals

A 401(k) loan allows you to borrow money from your retirement savings account. Depending on your employer's plan, you could borrow up to 50% of your vested account balance or $50,000, whichever is less. However, you will have to pay back the borrowed money, plus interest, within five years in most cases.

Now, let's focus on hardship withdrawals:

One of the pros of a hardship withdrawal is that you are not required to pay back the amount withdrawn from your 401(k) assets. However, there are also cons to consider. Hardship withdrawals are generally taxed as ordinary income, and a 10% early withdrawal penalty may apply if you are under 59½ years old, unless you meet IRS exceptions. Additionally, you may be prohibited from contributing to your 401(k) for a period after the withdrawal, causing you to miss out on potential growth and any employer matches.

It is important to carefully evaluate your options before making a hardship withdrawal. Consider seeking advice from a financial professional to understand the potential legal, tax, and estate implications. Additionally, consider alternative sources of cash, such as non-retirement accounts or emergency savings funds, before tapping into your retirement accounts.

Repaying 401(k) loans

Repaying a 401(k) loan is a crucial aspect of managing your retirement savings. Here are some key points to consider regarding loan repayment:

Repayment Period

Typically, you have up to five years to repay a 401(k) loan. However, this period may change if you leave your job before the loan is fully repaid. In such cases, your plan might require immediate full repayment of the outstanding balance. If you use the loan to purchase your primary residence, the IRS allows a longer repayment period.

Repayment Amount

The amount you can borrow from your 401(k) is usually limited to 50% of your vested account balance or $50,000, whichever is less. If 50% of the vested balance is less than $10,000, you may borrow up to $10,000. You must repay the borrowed amount, plus interest, within the specified period.

Repayment Frequency

Repayment plans can vary, and you can choose to make payments weekly, biweekly, monthly, or quarterly. Many plans offer the convenience of repaying through regular payroll deductions, which can be increased to clear the loan sooner than the five-year requirement.

Default and Early Withdrawal Penalties

If you default on your 401(k) loan, it won't negatively impact your credit score as defaulted loans are not reported to credit bureaus. However, the outstanding loan balance may be considered a withdrawal, and you may owe taxes and a 10% early withdrawal penalty if you're under 59½ years old.

Opportunity Cost

When you take a loan from your 401(k), you miss out on the potential growth of that money over time. Even when you repay the loan, the repaid funds have less time to grow tax-free. Therefore, it's essential to consider the opportunity cost of taking a loan from your retirement savings.

Maintaining Regular Contributions

While repaying the loan, it's tempting to reduce or pause your regular contributions to your 401(k) plan. However, maintaining your regular contributions is crucial to keeping your retirement strategy on track.

401(k) alternatives

Fidelity does allow 401(k) loans, but there are also other alternatives to saving for retirement. Here are some options to consider:

Individual Retirement Accounts (IRAs)

IRAs are a popular alternative to 401(k) plans and are available to any adult with earned income. They offer similar tax advantages, and you can choose between a traditional IRA or a Roth IRA, depending on your tax situation. With an IRA, you can invest in various securities or financial instruments, including stocks, bonds, mutual funds, real estate, and cryptocurrency. The contribution limit for IRAs is lower than that of 401(k) plans, but it still allows for substantial savings for retirement.

Self-Employed 401(k) (Solo 401(k))

If you are self-employed or own a small business, a self-employed 401(k), also known as a solo 401(k), can be a great option. It offers the same tax-deferral and pretax contribution benefits as a traditional 401(k) and allows for both employee and employer contributions. As the employee, you can contribute up to 100% of your compensation, with a maximum of $23,000 in 2024, and an additional $7,500 in catch-up contributions if you're over 50. As the employer, you can contribute up to 25% of your eligible earnings.

SIMPLE IRA

A SIMPLE IRA is another option for self-employed individuals or small businesses with 100 or fewer employees. It allows for both employee and employer contributions, with a maximum employee contribution of $16,000 in 2024. Employers must contribute either a 3% matching contribution or a 2% non-elective contribution.

Health Savings Accounts (HSAs)

While HSAs were created to help Americans with high-deductible health plans, they can also be used as a retirement savings vehicle. HSAs offer tax advantages and can be a great way to accumulate savings for the future.

Qualified Investment Accounts

Qualified investment accounts are another alternative to 401(k) plans. These accounts provide flexibility in investment choices, including the option to invest in real estate and cryptocurrency. However, there are extra IRS rules and reporting requirements to consider. Additionally, you must own a business to participate in these types of accounts.

Frequently asked questions