The first restriction on a 401(k) loan is that the total outstanding loan balance cannot be greater than 50% of the vested account balance, up to a maximum cap on the balance of $50,000 for accounts with a value greater than $100,000. Notably, under IRC Section 72(p)(2)(ii)(II), smaller 401(k) or other qualified plans with an account balance lower than $20,000 can borrow up to $10,000, even if it exceeds the 50% limit, although Department of Labor Regulation 2550.408b-1(f)(2)(i) does not permit more than 50% of the account balance to be used as security for a loan.
The second restriction on a 401(k) loan is that the loan must be repaid in a timely manner, which under IRC Section 72(p)(2)(B) is defined as a 401(k) loan repayment period of five years. In addition, IRC Section 72(p)(2)(C) requires that any 401(k) loan repayment must be made in amortizing payments — e.g., monthly or quarterly payments of principal and interest — over that five-year time period. Interest-only payments with a balloon principal payment are not permitted.
In our next blog post, we will discuss 401Ik) loan's rules on exceptions.