Fidelity's Policy: Contributions During Loan Periods Explained

When it comes to retirement plans, there are a variety of options to choose from, each with its own set of advantages and disadvantages. One popular option is the 401(k) plan, which allows employees to contribute a portion of their salary to a tax-advantaged account. While these plans typically offer a range of investment choices, one feature that stands out is the ability to take out loans or withdrawals. In this scenario, individuals can borrow from their own retirement savings, providing financial flexibility. However, it's important to remember that while this option may provide short-term relief, it can also set back your long-term retirement goals.

Borrowing against assets

Liquid collateral, such as securities, is generally preferred by lenders as it can be quickly converted into cash if the borrower defaults on the loan. However, it is important to note that the market value of the collateral may decrease, and the lender may demand immediate repayment or additional collateral.

There are several ways to borrow against your assets, each with its own benefits and considerations. Here are some common methods:

• Home Equity Line of Credit (HELOC): A HELOC is a line of credit backed by a residential property, usually the borrower's primary home. It is similar to a credit card in that you are given a maximum amount to borrow based on your home's market value and current mortgage balance. Interest rates on HELOCs are generally lower than those on credit cards, and you only pay interest on the amount you borrow. However, interest payments on HELOCs are generally not tax-deductible unless the funds are used to improve the home.
• Securities-Backed Line of Credit: This type of loan is backed by assets in a taxable brokerage or professionally managed account. You may be able to borrow a significant percentage of your portfolio's total amount, and the application process is typically minimal. Rates on securities-backed lines of credit are comparable or slightly lower than rates on home equity loans.
• Margin Loan: A margin loan allows you to borrow funds to purchase additional investments or meet short-term liquidity needs. The funds borrowed can be used for various purposes, and you may be able to deduct the interest paid if you itemize your deductions and use the funds to generate taxable income. However, if the value of your margin account falls below the maintenance requirement, your brokerage may issue a maintenance call, requiring you to deposit additional funds or securities or sell some of your assets.

It is important to carefully consider the risks and benefits of borrowing against your assets. While it can provide access to liquidity and potentially favourable interest rates, it also exposes your assets to increased risk. Additionally, maintaining a diversified portfolio can help reduce the risk associated with borrowing against your assets.

401(k) loans

A 401(k) loan is a loan taken 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. An exception to this limit is if 50% of the vested account balance is less than $10,000, in which case you can borrow up to $10,000. You will have to pay back the borrowed money, plus interest, within five years of taking out the loan.

The pros of a 401(k) loan are that you don't have to pay taxes and penalties when you take out the loan, and the interest you pay goes back into your retirement plan account. Additionally, if you miss a payment or default on the loan, it won't impact your credit score.

The cons of a 401(k) loan are that you are borrowing from your retirement savings, which can impact your retirement strategy. Also, when you repay the loan into your retirement account, that money will be taxed a second time when it is withdrawn.

It is important to note that not all employers offer a 401(k) loan option, and it is recommended to consider other alternatives before borrowing from your retirement savings.

For 401(k) plans, the employee contribution limit is $23,500 for 2025, with an additional $7,500 catch-up contribution allowed for employees aged 50 or older. Those between ages 60 and 63 will be eligible to contribute up to $11,250 as a catch-up contribution. This means that those aged 50 to 59 or 64 and older will be able to contribute up to $31,000 in 2025, while those aged 60 to 63 will be able to contribute up to $34,750.

Workplace savings plans

There are several drawbacks to consider before taking out a loan from your workplace savings plan. Firstly, if you leave your job with an outstanding loan balance, you must repay the full amount by the due date of your next federal tax return. Secondly, if you don't pay the loan back by the due date, it counts as a distribution, and you will likely have to pay income taxes and a penalty on the money. Finally, you'll miss out on the growth those borrowed funds may have experienced, which could set back your retirement goals.

It is important to keep contributing to your workplace savings plan while paying off a loan. This will help keep your retirement strategy on track. It is recommended to keep $1,000 or 3 to 6 months' worth of living expenses in a liquid account for emergencies, with the rest of your savings invested in a diversified portfolio.

There are several other options for borrowing money, such as a home equity line of credit (HELOC), a securities-backed line of credit, or a margin loan. Each option has different benefits and considerations, so it is important to understand them before making a decision.

Health Savings Accounts (HSAs)

A Health Savings Account (HSA) is a tax-advantaged account that can be used to pay for qualified medical expenses, including copays, prescriptions, dental care, contacts and eyeglasses, bandages, X-rays, and more. HSA contributions are federal income tax-deductible, and the unspent money rolls over every year. This means that you don't forfeit any money you don't use in a given year, and you can carry it forward until you want or need to use it.

You can open and contribute to as many HSAs as you like, but the annual IRS contribution limit applies to the total amount contributed to all your HSAs. For 2024, the contribution limits are $4,150 for individual health plans and $8,300 for family health plans. If you are 55 or older during the tax year, you may be eligible to make an additional $1,000 catch-up contribution annually. You can also make a once-in-a-lifetime contribution to your HSA from your IRA, which is not subject to federal income taxes or the 10% penalty for early withdrawals.

Fidelity offers HSAs with no account fees or minimums, and $0 commissions for US stock and ETF trades. You can make one-time or recurring contributions from a bank account or eligible Fidelity account, deposit a check, or set up direct deposit from your payroll. You can also transfer your balance from another HSA or HSAs to consolidate your accounts.

IRAs

Fidelity offers a variety of Individual Retirement Account (IRA) options to help you plan for retirement. IRAs may provide a tax-advantaged way to save for retirement and can be a good choice if you're self-employed.

Traditional IRA

A traditional IRA is a retirement account designed to help people save for retirement, with taxes deferred on any potential investment growth. Contributions are generally made with after-tax money, but they may be tax-deductible if you meet income eligibility. With a traditional IRA, you can withdraw money penalty-free for certain expenses, such as a first home purchase, birth, or college expenses. There are no income limits, so as long as you're working, you can keep contributing to a traditional IRA. The SECURE Act of 2019 removed the age limit for contributing to a traditional IRA, so anyone with earned income can contribute regardless of age. The contribution limit for 2024 and 2025 is $7,000 per year if you're under 50, and $8,000 per year if you're 50 or older.

Roth IRA

A Roth IRA is a good choice if you want to save for retirement with your after-tax income. It's also a great way to achieve tax diversification in retirement, as distributions of contributions are available anytime without tax or penalty, and all qualified withdrawals are tax-free. Additionally, there are no required minimum distributions. The contribution limit for 2024 and 2025 is $7,000 per year if you're under 50, and there is a "`catch-up`" contribution of $1,000 for those 50 and older.

SEP IRA

Simplified Employee Pension (SEP) IRAs are designed for self-employed individuals and business owners, offering an easy way to set up retirement savings and allowing larger contributions than a traditional or Roth IRA. The contribution percentage can vary each year, from 0% to 25% of compensation, with a designated annual cap.

Rollover IRA

A rollover IRA allows you to consolidate various types of retirement account balances, including 401(k) assets, 403(b) plan assets, and governmental 457(b) plan assets. However, if you want the option of rolling eligible assets from your IRA into another employer-sponsored plan in the future, it's recommended to keep separate IRA accounts for each retirement plan type.

IRA Contribution Methods

You can contribute to your IRA through Fidelity's transfer experience or via their mobile app. You can select the bank or brokerage account you want to transfer money from and then choose the retirement account you want to contribute to. You can also contribute by selling a Fidelity mutual fund in a mutual fund account and contributing the cash amount to a brokerage IRA, or by using cash from a brokerage account to buy a Fidelity mutual fund.

Frequently asked questions