Employer-sponsored 401(k) plans may have various loan provisions allowing participants to take loans against their retirement savings or take withdrawals in times of hardship. But before you consider borrowing money from your 401(k) plan, you will need to understand how your loans and withdrawals will affect your retirement goals and savings and what tax consequences you may trigger.

Many 401(k) participants make the mistake of tapping into their retirement savings when they need some cash. Unless you absolutely need it to meet short-term liquidy crunches, you should avoid withdrawing or borrowing against your 401(k) because its main purpose is to save for your retirement needs and goals for the future. If you make a habit out of taking money out of your 401(k) from time to time without even noticing it, you may run the risk of depleting your retirement assets before you retire. Additionally, depending on how you take the money out, you may face additional tax consequences and penalties for early withdrawals before the age of 59 1/2. However, when you need the money, you need the money, so if an emergency arises such as a college tuition bill from an Ivy League school, and your 401(k) plan is the only area where you can rely on to cover the educational expenses, borrowing from your 401(k) or outright withdrawing funds may be your sole option.

Plan loans Contact your plan administrator or read your 401(k) plan documents provided by your employer to check if you are allowed to withdraw or borrow money from your 401(k) plan and what reasons would constitute an eligible circumstance. Some employers will set the 401(k) contract terms to only allow 401(k) loans in cases of financial hardship, and some may allow you to borrow money to buy your first home, buy a car, or for some other purposes.

Typically, getting a 401(k) loan is simple. There isn't a stack of papers to sign or credit check to go through. The fees are negligible, which at most may include a small processing fee, and that's about it.

How much can you borrow? Generally speaking, even if you want to take a 401(k) loan, you are usually restricted by the retirement plan to borrowing no more than $50,000 or one-half the amount vested in the plan, whichever is the smaller amount. So you can't borrow the entire sum.

What about repaying the loan? Generally speaking, like any other loan, you will have to repay the loan you've borrowed from your 401(k) within five years. This will include payments at least quarterly to satisfy the two parts that make up the loan which are principal and interest. There are certain exceptions, for instance, if you borrowed the funds to purchase your home, you may obtain an extension on the repayment of the loan.

Complying with the repayment requirements of your loan is important. If you don't follow the instructions set out in the terms of the loan, the loan money will be considered as a taxable distribution which will trigger ordinary income taxes and a 10% early withdrawal penalties if you're under 59 1/2.

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