Fees, Interest Rates, And Taxes For A 401k Loan

A 401k loan allows you to borrow money from your own 401k plan. You’re allowed to borrow up to 50% of your plan value, up to a maximum of $50,000.

Here’s everything you need to know about a 401k loan’s interest rates, taxes, and fees.

What are the interest rates on a 401k loan?

The interest rates on a 401k loan is prime rate plus one or two percent. The prime rate is determined by individual banks based on the federal funds rate each year. The one or two percent is added by your 401k plan provider.

The U.S. Department of Labor (DOL) requires that interest rates be reasonable for loans from a qualified retirement plan like a 401k. Therefore, the rate will never be higher than one or two percent on top of the prime rate. A 401k plan provider is not allowed to charge unreasonably high interest rates.

For example, as of November 2022, the prime rate is 7%. Your plan provider would add another one or two percent on top.

Therefore, your 401k loan’s interest rate would be 8% or 9%.

With a 401k, all interest payments go back into your own account. They don’t count as repayment of the loan, just interest charges.

What is a prime rate?

The prime rate is the interest rate that banks charge their lowest risk customers that want to borrow money. Typically, it’s the lowest interest rate available, and is used for credit cards, lines of credit, and loans.

Banks will typically charge their customers with the highest credit scores just the prime rate. The surcharge added on top is based on a customer’s creditworthiness and the product type they want. The more likely a customer is to pay the money back, the lower the interest rate they’ll charge.

No creditworthiness required for a 401k loan

The best part of a 401k loan is that it’s fast, there’s no application process, and there are no credit checks involved. Even if you miss payments on repaying your loan, your credit score does not get affected.

The interest rates are the same for low credit individuals and high credit individuals. You don’t get better interest rates because you have a better credit score.

What are the fees on a 401k loan?

Depending on your 401k plan provider, there may be fees charged for taking out a 401k loan.

Origination fee: Most plan providers will charge an origination fee, which ranges in cost from $50 to $100.

Maintenance fee: Some plan providers will also charge a maintenance fee, which ranges in cost from $25 to $50.

In total, fees charged by plan providers for a 401k loan could amount between $75 to $150.

What are the taxes for taking out a 401k loan?

A 401k loan does not have any taxes for taking out the loan. However, your repayments have to be made in after-tax dollars. You cannot deduct your taxable income and use it to repay your loan. If you borrowed money from your traditional 401k (not the Roth 401k), you’ll also have to pay taxes when you make withdrawals in retirement. So technically, you’re having to pay taxes on the money twice.

What happens if I miss interest payments?

If you fail to repay your loan plus interest payments, your plan provider does not report the missed payments to credit reporting agencies. Instead, you’re penalized by the IRS.

Failure to repay your loan before the due date results in the IRS treating your loan as an early withdrawal, which are subject to a 10% early distribution penalty plus income taxes.

For example, if you took out a 401k loan for $50,000, you’ll have to pay $5,000 of it as an early distribution penalty tax, plus income taxes (dollar amount would be based on your tax bracket and tax rates at the time).

What is the due date for repaying a 401k loan + interest payments?

You’re given 5 years to repay your loan and all interest payments. If you use the money to purchase a primary residence, you could get up to 15 years to pay it back.

If you quit your job or get fired, you’ll have to pay back the loan sooner. Instead of having 5 years to pay it back, you’ll have to return the money in full, plus interest, by next year’s federal tax filing deadline. For 2022, the tax filing deadline is April 18, 2023.

Normally, the federal tax filing deadline is April 15, each year. However, April 15 falls on a Saturday in 2023, and the following Monday is a federal holiday. Therefore, the deadline gets pushed to April 18, 2023.