Can you borrow money from your 401(k)?

Can you borrow money from your 401(k)?
American currency and an egg with '401K' on it
Just keep in mind: Investing consistently for the long term is the best way to ensure you have funds for retirement.

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If you have a decent amount invested in your 401(k) and you need a short-term loan, you may be considering taking out a loan from the popular retirement vehicle.

There are many things to consider before taking out a loan from your 401(k), including potential penalties, taxes, and the possibility of a smaller retirement.

Before making many important financial decisions, it may be wise to consult with a financial advisor who can explain the impact.

Can you borrow from your 401(k)?

If your plan allows it, you can borrow up to $50,000 or half of your vested balance, whichever is less, according to the Internal Revenue Service. Many 401(k) plans, which are administered through employers, give borrowers up to five years to repay the loan, with interest.

There is one exception: If your 401(k) has an vested balance of less than $10,000, you can borrow up to $10,000. However, the IRS does not require plans to include this exception, so check with your plan administrator.

You’ll also want to verify that a 401(k) plan loan is an option (your plan may require your spouse’s approval). Again, talk to a financial advisor to see if this way of accessing funds makes more sense for you.

Can you borrow from your 401(k) without penalty?

Depending on what your plan allows, you can withdraw up to 50%, up to a maximum of $50,000, within a 12-month period. If you pay according to the terms of the loan, you will not be penalized.

But be careful: If you lose your job and don’t pay by that year’s tax due date, the IRS considers your loan a withdrawal. That means if you’re under 59½, you may have to pay 10% tax penalty for early withdrawal.

You can also do some rough calculations about early withdrawal costs using a 401(k) calculator.

How to Borrow Against Your 401(k)

You must apply for the 401(k) loan and meet certain requirements, which may depend on the plan administrator. Typically, a 401(k) borrower has to pay back the loan within five years. Most plans require payments at least quarterly or every three months.

There are some exceptions; again, it depends on the administrator. For example, if you use the 401(k) loan to purchase a home that will be your primary residence, the five-year repayment requirement may be waived.

Pros and cons of borrowing from your 401(k)

Expert Note consistently invest for the long term it’s the best way to ensure you have funds for retirement. So it’s a good idea to carefully consider the pros and cons of borrowing from your 401(k).

advantage

  • A 401(k) loan does not generate a “hard” credit inquiry from credit reporting companies and does not appear on your credit report.
  • Interest rates are set by the plan administrator and may be lower than other types of loans.
  • The interest on the loan goes back into the 401(k). You pay your own bill for the loan.
  • If you miss a payment on a 401(k) loan, it won’t affect your credit score
  • If you use the loan to pay off high-interest credit cards and pay off the 401(k) loan on time, you could reduce the amount you pay in interest overall.

cons

  • If you lose your job, you may have to pay the loan back in full.
  • Similarly, if you lose your job and don’t repay the loan by that year’s tax due date, the IRS may treat your loan as a withdrawal. If you’re under 59½, you may owe a 10% early withdrawal tax penalty.
  • You may end up with smaller retirement savings. This is because investment earnings will be built from a smaller base while your loan is outstanding.
  • If you stop contributing to the plan during the loan, you may miss out on matching funds offered by some employers.

Other options

  • A “hardship” withdrawal from your 401(k): There are some exemptions from the penalties generally associated with early withdrawal from a 401(k) loan, although the requirements are strict. For example, under the 2020 CARES Act, you can withdraw up to $100,000 from a retirement plan to pay for COVID-19 related issues. Check the terms carefully, as there are often penalties for withdrawing 401(k) funds early, and withdrawals can count as income, meaning you’ll pay taxes.
  • personal loan: If you credit score is good and you have room in your budget for the payment, a personal loan may make more sense than tapping into your retirement funds. Learn more about personal loans here.
  • Home Equity Loan: If your home is valued at more than the current mortgage on the property, known as equity, you might consider this type of loan. Home equity loans, or HELOs, generally have lower interest rates than other loans because your home acts as collateral.

Source : www.cbsnews.com

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About the Author: Pierre Cohen

A person who has expertise in politics and writes articles to fill his spare time as a hobby.