It’s no surprise that more and more people are turning to their 401(k) plans during times of financial hardship. After all, they tend to provide attractive loans at low-interest rates with some leniency on repayment periods - so borrowing from your 401(k) can definitely seem like a sound option.
Some may wonder if they are able to borrow from their 401(k) for use right now. Advice on whether or not to take a loan from your 401(k) is split. Some financial advisers say you should never even consider it. Others think there are certain situations when taking a short-term loan from your retirement savings is not the worst idea.
There are many things to consider when contemplating a loan from your 401(k): the amount of the loan, the length of the loan, the terms and limits of your 401(k) plan, how long you will remain in your current position, and more. Ultimately, it is up to you to determine the best decision.
If you are currently enrolled in your company’s 401(k) plan and loans are allowed, you may borrow up to $50,000 or 50% of your vested account balance, whichever is less.
Your vested account balance is the money that belongs to you. You are always 100% vested in your contributions, but your employer matching contributions may have different vesting schedules. For example, let’s assume your company matches 2% of the contributions you make to your 401(k) and you are vested after four years of employment.
You may only take a loan from the 401(k) plan of your current employer. If you have old 401(k) plans with former employers, you may not take a loan from those accounts.
Most 401(k) loans are required to be repaid through payroll deductions. These deductions are taken either quarterly or monthly, and they typically begin as soon as you take the loan. There are some cases where you may have less than 30 days to begin repaying the loan.
The interest rate you pay on 401(k) loans must be “reasonable,” according to the Internal Revenue Service (IRS). In most cases, interest rates are set as prime plus 1%. The total repayment is deposited into your 401(k) account.
When you take a 401(k) loan, there is no tax paid on the amount received. But, if you don’t repay the loan on time, any outstanding amounts will be taxed as a distribution and you may be required to pay additional penalties. Under the 2018 Tax Credit and Jobs Act, the final payment of your loan is due the same day your federal income tax return is due.
Most financial experts agree that taking a loan from your 401(k) plan account is not the best idea, especially if you don’t have any other retirement savings. They believe you are jeopardizing your future financial security.
Other disadvantages of borrowing from your 401(k) include:
If you borrow 401(k) funds to pay everyday debts like your credit card bill, mortgage or rent, you could potentially have a larger problem on your hands. A short-term loan may seem like a good idea but could result in long-term consequences.
If you choose to take a loan from your 401(k) plan, there are some perks.
You may take up to five years to repay your loan, and there are typically no penalties for prepayment.
While most financial experts do not recommend taking a loan from your 401(k) plan, there are a few situations some consider drastic enough to borrow the money from your 401(k) and pay yourself back.
Most 401(k) plans also allow for hardship withdrawals, which you do not have to repay. If you are in a situation like one of those listed above and have already maxed out your loan, you may be eligible to take the amount of money needed to pay the debt.
If you have any questions about your 401(k) plan or the loan features of the plan, be sure to talk to your human resources representative or benefits adviser. They can help you determine whether a loan is your best option and walk you through the process. They can also provide you with further details about a hardship withdrawal if needed. If you'd like guidance on getting started, contact us.
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