401(k) Loans
Perhaps you were unaware that you could borrow against your 401K. If your 401(k) plan allows loans and most do, you can borrow up to 50% of your vested account balance or $50,000, whichever is less. Repayment usually takes place over a five year period. This may be extended if the reason for your loan is to buy your first home. There is no penalty for borrowing on your 401K plan.
Before you consider a 401K loan know your facts and you can make an informed decision because as with any type of loan there are rules and regulations.
- Borrowing this way is easy and quick. A phone call often is all it takes to get the ball rolling or in some cases a short form is used to capture information needed to get at the money. It isn’t really a loan because it is your money.
- There is no credit check to slow things down because again it is not a typical loan situation.
- Interest rates are lower on 401K loans generally around a couple of percentage points above the prime rate.
- The interest you pay on the loan is yours so it stays in the retirement fund.
- In borrowing on your 401K plan, you bring down the balance of your investment fund and therefore you get interest paid only on what is left after you borrow. So there is lost income from interest, dividends and/or capital gains along with your other investments.
- When you pay back the loan, you pay with after tax dollars but the loan itself does not attract income tax so the loan is tax free.
- If you don’t pay back the loan, it is considered income and you will have to pay income taxes on the borrowed money and a 10% penalty if you are under age fifty-nine and a half.
- The loan is not tax deductible.
401K loans are best to avoid if at all possible. After all the 401K plan is intended for your retirement. The more you borrow from it, the less you will have for interest earnings. Also, studies show that most people who borrow from their 401K plans, cease making contributions to the plan, again reducing the amount of money you will have at retirement age.
When compared with 401K loans, home equity loans or low interest money market funds are more prudently financial options.
