Changing Jobs? Should You Borrow to Repay a 401k Loan?

Changing jobs can be exciting. But what if you have a 401k loan? This article looks at whether you should borrow money to repay a 401(k) loan when you change jobs?

repay a 401k loan

One feature of many 401(k) retirement plans is that you can borrow money from your own account. Regulations don’t require that 401(k) plans offer this option. But many do.

Financial gurus have written a lot about the pros and cons of 401(k) loans. It’s still a hotly-debated topic. One of the biggest potential drawbacks comes into play if you leave your job while you still have an outstanding loan from your 401(k) plan. So today, let’s take a look at what happens when you pull money from your 401(k) and whether you should borrow elsewhere to return the funds to your retirement account.

Leaving a Job With an Outstanding Loan

While many financial advisors would recommend (with a passion) that you never borrow money from your retirement plan, the fact is that it happens. Sometimes, an opportunity may present itself that warrants the 401(k) loan. Other times, you may make the choice out of sheer necessity. After all, a 401(k) loan is typically smarter than other “quick cash” options like payday loans.

If you’re considering a loan, know that you’re not alone. In fact, according to a 2014 study by the Employee Benefits Research Institute, 21 percent of employees who were eligible for a 401(k) loan had one outstanding. With so many people owing money back to their retirement plans, though, there’s the potential for an issue.

The biggest problem, as mentioned, is when you leave your job and haven’t paid the loan back in full. This may be because a better opportunity presents itself and you choose to change jobs. Or it might be because you are laid off or fired.

When this happens, you generally have two options: (1) pay back the loan in full within 60 days, or (2) …don’t.

If you follow option two, just know that the IRS will treat the loan as an early withdrawal from your 401(k) plan. With very few exceptions, they will then smack you with a 10% penalty on the outstanding loan amount and also require you to pay taxes on the distribution. Thus, you could easily end up paying 30% or 40% of the outstanding loan amount in penalties and taxes.

It goes without saying that failing to pay back the loan within the allotted time period can be a very costly decision.

How to Pay It Back Quickly

The problem that often arises is that folks want to pay back the 401(k) loan within the 60-day window. But they simply can’t afford to do so. This is particularly true in difficult economic times or when someone is unexpectedly let go from their job without time to financially prepare. In either case, borrowers often lack the available funds to repay the loan in the 60-day period.

That leads us to an important question: Should you borrow to repay a 401(k) loan?

The short answer, in my opinion, is absolutely yes. And to my surprise, it’s also Dave Ramsey’s advice. And we all know how much he preaches against non-mortgage debt.

It may seem a little like borrowing from Peter to pay Paul, but it has its merits. With the taxes and penalties you’ll owe if you don’t repay the 401(k) loan right away, the cost will almost always be greater than the cost of a short-term personal loan at reasonable rates. In addition, by not repaying the 401(k) loan, you will forever remove that money from your retirement investments. Thus you’ll lose the tax-deferred return on your 401(k) investments forever.

Where to Borrow

Of course, one big question still remains. Where should you look to borrow money to repay a 401(k) loan?

Here are a few places to look if you need to quickly return borrowed funds to your retirement account before being hit with fines and penalties:

  • Home Equity Line of Credit (HELOC): Perhaps the first option would be to tap into a home equity line of credit. Equity lines generally come with reasonable interest rates and are easy to access if you have some equity built up in your home.
  • 0% Balance Transfer cards: Another potential option is to take advantage of one or more 0% balance transfer offers. Before going this route, however, make sure you can pay off a 401(k) loan balance with the balance transfer card(s). Depending on how much you borrowed, you may still come up short. Also keep in mind that the introductory rate periods are frequently as low as six months. After that, the interest rates adjust to whatever regular APR applies to the card. That can be as high as 20-30 percent! This option is best if you can repay the money transferred well before the introductory APR expires.
  • LendingClub: A popular peer-to-peer lending source, LendingClub offers unsecured loans up to $25,000. Depending on your credit history, credit score, and other factors, you can obtain a loan at a reasonable interest rate. All loans must be repaid over three years, although you can choose to pay off the loan sooner.
  • Unsecured Line of Credit: You can obtain unsecured lines of credit from most banks and credit unions. Interest rates will vary significantly based on your credit history. I have an unsecured line at Citibank that I rarely use, but it does come in handy for short-term loan needs.

So, what’s your take? Should you borrow to repay a 401(k) loan if you don’t have the funds available to repay the debt?

Topics: Personal Finance
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49 Responses to “Changing Jobs? Should You Borrow to Repay a 401k Loan?”

  1. If the new employer offers 401(k) and you are transferring the plan to the new employer, can you also roll-over the loan and continue paying regularly the new employers plan?

  2. Katie Wellington

    My husband took out 15,000 from his 401K, then was laid off.. can he A. have the repayment come out of our direct acct or B since we are rolling our 401K’s into one, could they take repayments out of his checks from a new job or mine?

  3. I owe 3k on my loan with current employer. I have plans on going on to a new job. I understand that I have 60 days to pay the loan back. My question is can I use my rollover 401K money to pay my existing loan? Also can I have the financial institution take out the takes that I would owe if I decided to cash a portion of it out?

  4. I have a loan on my 401K the quesition I have is when the payment to the loan is paid from my Bi-Weekly paycheck the amount of the payment comes out after taxes so I’m paying taxes on the money I pay back them I will be taxes again when I draw it out for retiremnet?

  5. Its actually not a legal requirement that 401k loans have to be repaid when you leave the company. My employer does not require immediate repayment. For me the #3 option is to continue to simply repay the loan as per the loan terms.
    Check your 401k plan loan details to see IF repayment at termination is actually a reuirement. I suspect its a typical requirement since everyone seems to think this is the ‘rule’. But there are exceptions.

  6. I have 401k from my former employer that I left 3 months ago. I needed to borrow money for an emergency situation so I looked into my 401k plan and they had an option to borrow as a loan or withdraw funds. Obviously I chose the loan option because it’ll give me time to pay it back with minimal interest and no penalty. Well it turns out I shouldn’t have been allowed to borrow as loan because im no longer an employee and TD is telling me its considered a withdrawal and I have to pay it back full in 60 days plus penalty. I have not received the check yet and they would not allow me to cancel the request. What are my options? I dont want to pay penalty and taxes.

  7. Hello,
    I am planning to find another job, out of state. But I borrowed money from my 403b and still owe around 16,000. Could you help me figure out whats the best thing to do. I want to have a retirement account but I also want to build a ***6 months emergency fund*** Please help.😩

  8. So my company was not sold but it merged with another company under a new name. As of the first of the year we will have a new 401k company we will have to use.
    My question is: I have a loan through my 401k… will it rollover to my new 401k and will just make payments to them? NO ONE at this company seems to know the answer!!!

  9. I have a an approximate $20K loan from my 401(A) account from my previous employer. If I “roll-over” my 401(A) from the previous employer to my new employers 401(A) plan , how is the loan handled? I do not think i can afford to pay it off before the roll over deadline?, Depending on interest rates i qualify for, should i take a loan to pay it off first before rolling it over?

  10. Are there any special considerations when the “new” company uses the same brokerage to manage the 401k? I’m about to give notice to company #1 to accept a position with company #2 – and they both use Fidelity to manage their 401k accounts. Can’t I just leave the loan in place with Fidelity, and transfer both the account balance and the loan “in place”? It’s not like I’m taking possession of the funds – they’re staying in place!

  11. I am planning to quit my job before the end of the year and I still owe my 401k $5k from the $10k that I borrowed and I don’t think I will be able to pay the $5k i owe before I quit my job. Can I cash out my 401k money which about $50k even if I don’t pay the $5k that I still owe?

    • Rob Berger

      Antonio, my guess is they will deduct what you owe before cashing you out, but your HR department or 401k plan administrator will have the answer. Keep in mind that if you cash out a 401k, you may owe a 10% penalty (depending on your age and other circumstances) and taxes.

  12. I have a question and I hope someone can answer it. I plan on leaving my job mid December next year after I am out of school. I will still owe around 1800 on my 401K, and I should have around 6000 in my 401K around the time when that comes, as well was over 3000 in My profit sharing plan. The plan is to start my own business and cash out the rest of the money from the 401K and profit sharing plan to live off of while I get everything off the ground. By that point in time I should probably have 3 or 4000 in my savings account. Should I pay off the loans and then cash out the 401K and profit sharing or just have them deduct the remainder and take their cut?

  13. Veronica, they will deduct what you owe and that $900 will probably be eaten up by penalty fees for not paying back the loan. Basically transforming it to a withdrawal. Then you will have to claim the amount leftover on the loan as income so you will be taxed again depending on your tax bracket.

    • Rob Berger

      Rose, typically if you cash out a 401k before you are 59 1/2, you pay a 10% penalty + taxes. There are exceptions to this rule, however, so you should consult a tax professional before making a final decision.

      • Hi Rob, I just borrowed $1100.00 from my 401k and I had a job offer wich make better pay the my old job and I excepted the new job. Can I still withdraw the other half if I try to roll over my 401k to 403b?

  14. So I quit my job and was paying back on a 401k loan, I have almost $900 more in my 401k account than what I owe, I am going cash out on it because of my new job I don’t get paid until 45 days after I started and need the cash. My question is when i cash out will I get my full amount in my account or will they deduct what I owe on my loan and give me the almost $900 that’s left after the loan ? And what penalties will that cause during income tax time ? T.I.A !

  15. Hello, I was looking to see if my questions was already answered here, but it was not quite clear. So I took out a 401k, if I leave my company can the loan be deducted from the positive balance from my 401k. For example, I took out t $6,000 loan and my current balance is $46,000. So could they just distribute or roll-over $40,000? Thanks.

    • Stephanie Colestock
      Stephanie Colestock

      Karen,
      Unfortunately, you will actually need to pay back what you borrowed against the 401k. It cannot simply be deducted against your balance without penalty.

      Typically, you’ll have 60 days after leaving the company to repay the loan in full if you want to avoid it being counted as a taxable distribution (which would then be reported on a 1099-R). If you’re younger than 59.5, you’ll also have to worry about an additional penalty (of 10%) for taking an early distribution, if you don’t pay it back before the deadline.

      Best, Stephanie

  16. So how does that work? If the company takes the money from your 401k to pay your loan, the loan was to yourself, so does that money go back into the 401k, In other words do you still have that amount from the loan back into your 401k?

    • Stephanie Colestock
      Stephanie Colestock

      Terry,

      If you take out a 401k loan, it will come directly out of your 401k (tax-free) and be paid out to you. Then, you will repay it over a period of time back into the 401k — but you’ll also pay yourself interest on the loan (which also goes into your 401k account). So, yes, you’ll still have that money in the end (plus interest) after you finish repaying the loan.

      • Tired-Tried

        I received a 1099R this year for a loan I took out in 2016. The employer did not pay anything on the loan but they did and are still taking money out of my check. They are also taking money out for my 401K weekly but have only made 1 payment this year. Its sad when people lie cheat and steal.

  17. jamey beavers

    Debbie what your saying makes perfect sense. Where i work you can borrow up to half of what you have in your account so the other half is like collateral if you leave the company.

    • Chris Watson

      This is not correct. The money you borrowed from your 401k is your money whether you pay it back or not. If not you are subject to the tax penalty and regular taxes as if you had received that same money as income. There is no way that any employer can take money from your 401k to satisfy a loan that you have taken from the 401k. You have not borrowed from the employer. You have borrowed from yourself. This should be investigated as a legal problem. Its not collateral at all. That is not how a loan from 401k works.

  18. “Debbie stanovcak says:
    June 30, 2015 at 10:52 am
    My husband left a job with an outstanding 401kloan. The company took the amount owed on the loan from his 401kloan account to pay off the loan, why?”

    What? What you are saying doesn’t even make sense.
    The company your husband worked for used money from his 401k account to pay off his 401k loan? Hardship loan maybe? I mean, come on, you HAVE to have more information than this.

  19. varunee browder

    I had borrowed from my 401 k to pay my high interest credit card during my husband secound laid off for 11months, with 2 childrens in school, we depleted our saving.I need to pay some of my high interested credit cards off, so I can affort to make other payment and take care my family. I did have plan to change job, so i called the company 401 plan and the adviser told me that I can continue to make the payment by set up the checking acct. so they can withdraw from them each month automatic.When i change the job, and i did what I was told, the 401k plan send me the paper that I need to pay off total amount with in 2 months, otherwise i have to pay the tax and penilty, and they siad they are sorry that their employee gave me the wrong advised. My ignorant and trust to the company’s financial adviser that they know what they doing bacause I don’t.I have fairly decent education and like to prepare ahead,what about other people whom don’t have that opportunity? I hope the government understand that some people work hard to make a living honestly never get the break. why is that?

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