Should I Borrow From My 401(k) Plan?
January 8, 2007 Should I borrow from my 401(k) plan? This is a question that you may get from time-to-time from participants or even family and friends. While the answer in most cases is no, it is important to understand the pros and cons of 401(k) participant loans and the facts and circumstances of the individual. To help you answer this question, I put together a list of reasons to take or avoid taking out a 401(k) loan. A good reason to take out a 401(k) loan is because: - There is no credit check.
- It is convenient. For many plans you can apply online or with a telephone system in a matter of minutes.
- The interest you are paying is reasonable. The rate is set by the plan and is usually one or two points above the prime rate (currently 8.25%).
- There are no restrictions. You can borrow at any time for any reason.
- You are paying interest to yourself.
- The interest you are paying yourself is providing you with a reasonable rate of return (currently 8.25%).
- You do not have to pay taxes on the interest you are earning until retirement (or when you take a taxable distribution).
- You select which investments will be sold to fund the loan.
A good reason to avoid taking out a 401(k) loan is because: - If you leave the company for any reason, you will most likely have to pay the loan in full right away. If you cannot pay the loan right away (usually within 60 days), you will be in default, taxed on the full balance, and may need to pay a 10% penalty.
- You may need to reduce the contributions you are making to your 401(k) plan to make the loan payments. This will ultimately reduce the amount available to you at retirement.
- The interest you are paying yourself could provide a smaller rate of return than the investments that the money would have otherwise been invested in. This “opportunity cost” will be compounded over time and ultimately reduce the amount available to you at retirement.
- The interest you are paying yourself will be taxed twice, once when you originally earned the money (e.g. from your paycheck) and again when it is withdrawn from the plan.
- You have very limited flexibility with setting up or changing the payment terms of the loan.
- You are spending money that you have already saved.
- You may change your retirement savings mindset. The money you are saving is for your retirement.
- You may be charged loan fees.
There are many online sources of information about 401(k) loans, including the following: Warning: 401(k) loans are hazardous to your wealth
401k Plan Loans - An Overview
|
