When you have a pressing financial need, it might make sense to tap into your 401k by applying for a loan. But even though you’re technically borrowing money that you already own, you’re not always guaranteed of having your loan application approved. In fact, your 401k might not even allow loans.
A 401k loan can be denied because plan administrators aren’t legally required to allow such loans. Your application may be rejected because you’re exceeding the loan limit, have a lack of spousal consent, or being too close to retirement. Your 401k plan might also not allow loans due to plan policies.
Read on to find out how much power your employer has over your 401k loan application and the reasons why it might be rejected.
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Can Plan Administrators Reject a 401k Loan Application?
Plan administrators can reject a 401k loan application despite the fact that you want to borrow from your own savings. The IRS has set several regulations for 401k loans that articulate everything from what happens if an employee leaves a company to the period within which such loans must be paid.
Among these regulations is the maximum amount a participant may pull from their retirement plan as a loan. This figure can be either 50% of your vested account balance or $50,000一whichever is lower.
The only exception to this rule is when the value of 50% of your vested balance is lower than $10,000, which is when you might be able to borrow up to $10,000 from your 401k as a loan. However, whether or not to allow this exception is entirely up to the plan administrator’s policy.
Whether to allow an exception to the 50% rule isn’t the only thing left to the discretion of your plan administrator.
A plan administrator may allow 401k loans, but they’re not legally obligated to do so. As such, your employer can prohibit 401k loans entirely. They may also put limitations on loan availability as they deem fit.
Most commonly, these limitations restrict eligible 401k loans to the following purposes:
- Covering medical expenses.
- Settling educational expenses.
- Purchase of the participant’s first home.
In some cases, plan administrators may also prohibit participants from borrowing 401k funds they’ve contributed towards the employee’s account.
As you can see, employers have a lot of freedom when it comes to determining 401k loan distributions. If your employer rejects your application for a 401k loan, there isn’t much you can do about it except seeking alternatives.
Common Reasons Why 401k Loans Are Denied
Plan administrators may deny 401k loans for various reasons. Some of them may be within your control, while others may be things you can’t change.
Most commonly, your 401 loan application will be rejected because:
- Your spouse didn’t consent.
- You’re close to retirement.
- You’ve already exceeded your loan limit.
- Your job position risks elimination due to restructuring.
- You have/may qualify for alternative sources of funds.
- You’re seeking a 401k loan for non-qualified expenses.
Let’s discuss each of these reasons in greater detail.
Your Spouse Didn’t Consent
Not all 401k plans have this requirement, but some plans require you to provide written consent from your spouse for any loans exceeding $5,000. Usually, plans with this requirement will feature a form labeled “spousal consent” as part of the loan application paperwork.
While plan administrators aren’t obligated to include this form as part of the loan application documentation, many companies do it to minimize the chances of legal issues down the line.
For instance, your employer could face legal liability if your spouse is awarded half of your 401k in a divorce settlement, only for the court to discover that you’ve already been allowed to take out a significant chunk of it as a loan.
Given these potential legal consequences, your plan administrator may reject your 401k loan application if it isn’t accompanied by a signed spousal consent form.
You’re Close to Retirement
Many employers might reject your application for a 401k if you have less than five years to retirement. The explanation for this has a lot to do with the IRS-stipulated repayment period for such loans, which is five years.
For illustration, let’s assume you take a loan two years before your retirement. In this case, your repayment period would stretch beyond your retirement date.
More often than not, repayment periods that stretch beyond the retirement year increase the risk of default. That’s because 401k loans are typically repaid through payroll deductions, and retirees don’t receive these.
So if you take out a loan two years before retirement, there will be a three-year period after retirement where you’re repaying the loan out-of-pocket. For many individuals, paying out-of-pocket increases the chances of default.
And even if this doesn’t apply to you, your employer might not trust you to keep repaying after retirement.
You’ve Already Exceeded Your Loan Limit
As mentioned earlier, there’s always a limit to the amount of money you can borrow from your 401k.
If you’ve previously taken out a loan and are seeking a new one, the new loan should bring the total amount you owe up to 50% of your vested account balance, or $50,000. If it causes your debt to exceed this amount, then the new loan won’t be approved.
Some plan administrators won’t even allow new loan applications for up to six months after fully repaying your previous loan.
Others won’t allow you to take out more than one 401k loan at a time and will reject new applications until you clear the existing debt and wait for at least six months. This might be longer or shorter depending on the employer.
Your Job Position Risks Elimination Due to Restructuring
Sometimes, restructuring processes might scrap away some job positions or even entire departments. If your job is at risk, your employer might temporarily suspend 401k loan approvals until they’re done restructuring.
You Have/May Qualify for Alternative Sources of Funds
Ideally, your employer wants you to request a 401k loan only if you have no alternatives. So if they’re confident that you have other sources of funding available apart from your 401k, they might reject your loan application to discourage you from turning to your retirement plan for every minor financial problem.
You’re Seeking a 401k Loan for Nonqualified Expenses
Different plan administrators have varying 401k loan issuance policies.
These policies stipulate everything from which employees qualify for such loans to the specific expenses for which you might request a loan.
Most commonly, plan administrators limit eligible expenses to demonstrate financial hardships and emergencies. An imminent eviction, for instance, may qualify as financial hardship, while certain medical expenses might pass as emergencies.
Luxuries like a vacation typically don’t qualify as emergencies or financial hardships.
If you submit a 401k loan application for an expense that’s nonqualified per your employer’s regulations, it’ll be rejected. Usually, you can readily find out which expenses qualify for such loans from your plan administrator, so be sure to find that out if your application keeps getting knocked back.
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Conclusion
Indeed, your plan administrator has a lot of say when it comes to approving or rejecting your request for a 401k loan.
If the reason for rejection is something you can’t change, you might be better off seeking an alternative source of funding such as a personal loan, a home equity loan, or cash out 401k if you’re older than 59 ½ years.
If you really need cash, you may need to locate alternative sources first before hitting up your 401k plan.
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