What You Need to Know About 401(k) Loans
Borrowing from your 401(k) may seem like easy money—but know the pros and cons.
If you’re finding credit hard to get or you don’t have as much equity in your home these days, taking out a loan from your own 401(k) plan may be appealing. After all, most employers allow this, although some only allow the loans for buying your first home or paying un-reimbursed medical expenses.
Your 401(k) is long-term investment. Remember that. Removing funds to meet a short-term goal is only beneficial if are able to pay back the loan as quickly as possible. Here are some other points to keep in mind if you’re considering a 401(k) loan:
- You’ll avoid a credit check and gain low interest rates on the loan repayment.
- You can usually take a loan for up to 50 percent of your vested 401(k), up to $50,000.
- The repayment installments are deducted directly from your paycheck.
- When you borrow from your 401(k), the interest you repay goes to you and not a bank.
- You avoid taxes on the interest until you remove your money from the plan in retirement.
- It can be difficult to plan how to pay back the loan. What if you can’t afford the loan payments and you are unable to continue to put money away for retirement? Taking out a bank loan, instead, gives you access to a loan officer who can advise you about what you are able to pay back.
- Experts caution against missing payments. Outstanding balances and associated interest are identified as a distribution and distributions are taxed.
- If you quit or are fired from your job, you are required to repay 401(k) loans back within 60 days. Any outstanding balances are counted as distributions and, similar to missing payments, they accrue penalties with income tax.
- The time that your money is out of your 401(k) is time that the interest is not compounding and working for you.