If you need short-term funding, you may be able to take a 401(k) loan against your retirement savings. Whether you need the funds for college, home renovations or to buy a business, you should check the plan document to determine if you qualify for a 401(k) loan. Generally, the IRS allows 401(k) plans to offer 401(k) loans to participants, but the decision to approve or deny the loan request lies with the 401(k) plan.
A 401(k) plan could deny your 401(k) loan request for various reasons. Your 401(k) loan could be denied because you are nearing retirement, your job will be scrapped off in a restructuring process, or if you have exceeded the loan limit. If your 401(k) loan was denied, you should find out why it was denied.
Reasons why a 401(k) loan can be denied
A plan sponsor may reject your 401(k) loan due to the following reasons:
You are nearing retirement
If you are a few months away from your retirement, the employer may deny the 401(k) loan to avoid the risk of default. Usually, 401(k) loans are paid back through payroll deductions, and once an employee retires, they will no longer receive periodic paychecks. Instead, the employee will be solely responsible for loan repayment, which opens doors to default. Due to the risk of missing out on loan payments, the employer may reject the loan if the repayment period stretches to the period after retirement.
You’ve exceeded the loan limit
401(k) loans allow employees to borrow $10,000 or up to half of their vested balance, with a maximum of $50,000. If you have reached this limit with the first loan, the employer will likely reject the second loan. Some employers may require participants to wait at least 6 months after paying off a loan before they can take another 401(k) loan.
Also, some 401(k) plans allow participants to take one loan at a time. If you have an active loan, your loan request could be denied until you’ve repaid your current loan and completed the required waiting time.
Your job position could be eliminated in a restructuring
A company undergoing a restructuring process may suspend 401(k) loans to employees who are likely to lose their jobs. For example, if the company plans to scrap off a specific department, the employees working in that department could be denied a 401(k) loan until the restructuring process is complete. This way, the employer avoids a potential hardship on the part of the employee, who may struggle with the loan repayments if they are laid off.
You need the loan for luxury purchases
Taking a 401(k) loan for elective purposes such as buying gifts, vacation, or entertainment could be denied. Most 401(k) plans provide loans to participants who are facing financial hardship or have an immediate emergency need such as medical expenses or college education. If the reason for the 401(k) loan is a luxury expense that does not meet the financial hardship criteria, the loan application could be denied.
You could obtain funds from other sources
When borrowing from a 401(k), you must first exhaust all other sources of funding. A 401(k) loan should be the last resort since withdrawing from your retirement savings could jeopardize your future income. If the employer establishes that you have other assets that you could tap into to meet your financial needs, the 401(k) loan request could be denied. For example, if you are borrowing to pay for college, you must first exhaust other sources of funding such as college loans, grants, and scholarships before being approved for a 401(k) loan.
You are borrowing to finance everyday expenses
The purpose of a 401(k) is not to issue loans; rather, its primary purpose is to help employees build a retirement nest egg. Therefore, participants are not allowed to borrow against their retirement savings to pay everyday living expenses. If a 401(k) plan issues too many loans against the IRS rules, it risks losing its tax-favored status.
Alternatives to taking a 401(k) Loan
If you are denied a 401(k) loan, you should consider getting funds from other sources. Here are the alternatives of a 401(k) loan:
Personal loan
You can take a personal loan to help you finance a home renovation or pay medical expenses. If you have a good credit score, you may qualify for a personal loan with a favorable interest rate. Also, the personal loan may have better terms than the 401(k) loan.
Home equity loan
If you have accumulated enough equity in your home, you can take a home equity loan to meet your financial needs. A home equity loan has a relatively low-interest rate, and it can be an alternative option if your 401(k) loan application is denied. However, in case you default on the home equity loan, you risk losing your home.
Cash out 401(k)
If you are 59 ½ or older, you can start taking distributions from your 401(k) account without paying penalties. You can take out money from your retirement savings to pay for the immediate expenses, instead of having to make periodic payments to the 401(k) account with interest.
