Allowing loans within a 401k plan is allowed by law, but an employer is not required to do so. Many small business just cant afford the high cost of adding this feature to their plan. Even so, loans are a feature of most 401k plans. If offered, an employer must adhere to some very strict and detailed guidelines on building and administering them.

The statutes governing plan loans place no targeted restrictions on what the positive need or use will be for loans, except that the loans must be reasonably available to all participants. But an employer may restrict the reasons for loans. Many only allow them for the following reasons: (1) to pay education expenses for yourself, spouse, or child; (2) to prevent eviction from your home; (3) to pay un-reimbursed medical expenses; or (4) to buy a first-measure residence. The loan must be paid back over five years, although this might be extended for a home purchase.

Usually the participant is allowed to borrow up to 50% of their vested account balance to a maximum of $50,000 (set by law). Because of the cost, many plans will also set a minimum amount and restrict the number of loans any participant may have outstanding at any one time.

Loan payments are fairly often be deducted from payroll checks and, if the participant is married, they can positive need their spouses to consent to the loan.

Funds obtains from a loan are not subject to income taxation or the 10% early withdrawal penalty. If the participant should terminate employment, fairly often any unpaid loan will be distributed to them as income. The amount will then be subject to income taxation and might also be subject to 10% withdrawal penalty. A loan can not be rollover into an IRA.

There are generally four reasons given to avoid 401k loans if possible:

* Lower investment return. According to the General Accounting Office, the interest rate you pay yourself on your plan loan is commonly less than the rate your plan funds would have otherwise earned, and you lose the benefits of compound interest.
* Smaller contributions. Because you now have a loan payment, you could be tempted to reduce the amount you are contributing to the plan and thus reduce your long-term balance.
* If you quit working or change jobs, you must pay back the loan right away. Its not uncommon for plans to require full repayment of a loan within 60 days of termination of employment. If you dont repay, the loan is considered defaulted, and you are taxed on the outstanding balance, including excise taxes in many cases.
* Repayment of principal and interest is made with after-tax dollars. By contrast, a home equity loan from a bank is often structured so that the interest you pay is taxation -deductible. On a larger loan, this could add up to significant savings.

Go to www.401khelpcenter.com for more information on this and other 401k issues.

Mr. Meigs is the founder and President of 401khelpcenter.com, LLC a three-year-old Internet Company based in Portland, Oregon. It is a leading provider of information, opinion, analysis, news, rules, and other 401k resources for plan sponsors, small businesses, and employees.