Loan cure period

What is a loan cure period in a 401(k)?

When a participant takes a loan from their 401(k) account, they are required to make regular payments to pay back the loan. The 401(k) plan document and loan policy often include a loan cure period, which is the specific period of time during which the participant can catch up on any missed loan payment(s). 

If payments are still owed after the cure period ends, the loan will be in default. The cure period acts as a safety net, giving the participant additional time to make up for the missed payment and avoid the potentially significant tax consequences associated with loan default. 

What is a 401(k) loan?

A 401(k) loan allows you to borrow money from your active 401(k) account. This type of loan provides a way for you to access savings before retirement under certain conditions. When you take a loan from your 401(k), you are essentially borrowing from yourself. This means you are withdrawing funds from your retirement savings but with the intention of repaying them back into your account with interest. 

Here’s what you need to know about the process and the loan agreement:

1. Amount of the loan: Typically, you can borrow up to 50% of your vested account balance or $50,000, whichever is less.

2. Repayment terms: The maximum repayment term is generally 5 years. All payments (which include principal and interest) must be made at least quarterly, although most plans require payment through the regular payroll process. 

3. Interest rates: The interest rate on a 401(k) loan is stated in the plan’s loan policy and is typically comparable to the rates on a personal loan.

4. No credit check required: Since you are borrowing your own money, no credit check is needed, which makes it an attractive option for individuals with poor credit scores.

How long is the cure period for a 401(k) loan?

The length of the cure period for a 401(k) loan can vary depending on the plan’s specific terms and conditions. Generally, the longest cure period available under the law is until the last day of the calendar quarter following the quarter in which the missed payment was due. 

For example, if a borrower misses a monthly payment due in July, they would typically have until the end of December to make up the missed payment. It's important for 401(k) participants to review their plan documents for specifics about the cure period as it can have crucial implications on the management and repayment of the loan.

What happens if you miss a payment on a 401(k) plan loan?

When you borrow from your 401(k), you're expected to make regular payments, typically through payroll deductions. If you miss a payment on your 401(k) loan, what happens next can depend on the loan policy set by your plan. Generally, most 401(k) plans offer a cure period after a missed payment. During this time, you can make up the missed payment without facing immediate penalties.

If the payment is not made within the cure period, the loan is in default. A defaulted loan can trigger significant consequences including taxes and penalties. Specifically, after default, the remaining balance of the loan is treated as a taxable distribution, and if you are under the age of 59½, you might also be subject to a 10% early withdrawal penalty. The plan will issue you a 1099-R to include with your taxes

Can you extend the cure period for a 401(k) loan?

The duration of the cure period is predetermined by the plan's loan terms and cannot typically be modified on an individual basis. It’s crucial to check with your plan administrator to understand the specific terms of your 401(k) loan, including the length of the cure period and the options available if you're at risk of missing a payment.