HomeLifestyleThings to Know before Taking a 401(K) Loan

Things to Know before Taking a 401(K) Loan

Things to Know before Taking a 401(K) Loan

Several companies that permit you to borrow from your 401(K) plans, but statistics show that only 20% of employees eligible for the benefit end up taking this loan. This may be because they understand that borrowing from their 401(K) plan may not be the right course of action, even if they need cash right away. So, if you understand the basics of 401(K) loans, you would see why people call it “the last resort.”

At the same time, there are times when borrowing may be a sensible thing to do or the only option left to save you from a possible financial disaster. This is when you need to understand the basics of 401(K) loans and evaluate its pros and cons before you sign on the dotted lines. On the one hand, you get to borrow without having to go through a credit check, but on the other hand, it may culminate in lost investment growth, which is not desirable at all.

401(K) loan basics – 10 things to know before borrowing from your retirement plan

  • You must understand that a 401(K) loan has limits to borrowing. The Internal Revenue Service (IRS) has limited the amount to either 50% of your retirement balance or $50,000., but your plan provider may or may not accept these terms and may also offer you less.
  • You have to start repaying the loan at the start of your next pay-period, and it is usually through an automatic payroll deduction.
  • You may have to repay the loan in 5 years or less, unless you have used the cash to buy a home. This, however, may be a problem if you quit your job.
  • You may be able to skip a credit check as you do not borrow the money from a commercial lender or bank in case of a 401(K) loan. You simply tap into your retirement savings, but you have to pay interest.
  • Among the basics of 401(K) loans is that have very competitive interest rates. You repay the loan to yourself along with the interest, and not to any bank, so the whole amount that you repay each time goes into your retirement account. This is a huge advantage when you borrow to pay off high-interest loans and credit card payments.
  • 401(K) loans have minimal application fees, but plans charge an origination fee that can be up to $75 for every loan.
  • The money you borrow from the retirement account will remain outstanding, which means you have to forgo all prospective investment benefits until the loan is repaid.
  • When your money stays in the plan, it is creditor-protected. This means that if there is a bankruptcy, you are protected. So, it is foolish to cash out your 401(K) plan to pay off debts when you are more than likely to file for bankruptcy eventually. Bankruptcy courts will never touch your money when it is in a 401(K) plan.
  • You will be responsible for paying taxes or penalties if you cash in the plan and have not reached 59.5 years of age. The amount withdrawn becomes subject to regular income tax and penalty tax.
  • Some plans also stop you from making contributions until the loan is repaid. This only serves to derail your savings plans, so it is best to look at other options instead of cashing in the 401(K) plan.
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