You are thinking borrow money from your 401k?
If you find yourself in need of money and you’re thinking of borrowing directly from your 401k, better think twice. While it is true that seems to be an easy solution because after all it is your money and you do not need a review of your credit history or fill out cumbersome applications, the reality is not as simple as it seems.
There are some very important details that you should consider before making the application. Among them:
Paying the loan 401k
First you must consider that if for some reason you stop working or change jobs, the plan and the loan conditions may require that the loan is paid in full within 60 to 90 days from the date of the last day of work.
If you do not cancel the loan within the agreed period, the outstanding balance would be taxed as part of your income; and depending on your age, also you would be subject to the 10% early withdrawal penalty.
This penalty would apply if you are under 59 ½ years.
It is important to note that the money that is borrowed will be paid with money that has already been taxed. This means that your payments are taxed twice: First when you make the loan payment, and second, when you withdraw the money at retirement.
Also, the loan interest 401 (k) are not deductible; therefore, there is no tax benefit, so you use the money for buying your first home.
Likewise, the withdrawals from the plan means you have less money invested in the plan could well be generating more profits. Therefore, you should consider how this amount could grow if you leave it in the plan.
The moment you take the loan, you automatically reduce your ability to make contributions to the plan, which both affect the long-term growth of the balance, as any amount to be deducted from your salary will go to first pay off the debt instead of being a contribution that contribute to the growth of the balance.
The fact that you are removing some of your money, does not mean it is free of cost. Plans generally charge a fee for originating the loan, it can reach $ 100, and may also have an annual maintenance fee. This means that if the loan amount is $ 1,000, and the loan origination fee is $ 80, the cost would amount to 8% of the loan value. And if there is an annual maintenance fee of $ 20 and the loan is for three years, will end up paying total $ 140 on rates, ie 14% of the loan value.
To this we must add the interest that usually are very low and are based on the prime rate + 1%. However, interests are a direct accreditation to your account, and technically are not considered costs because eventually help increase the balance of your retirement account.
There is a ceiling on the loan amount to the 401 (k) can grant and can be $ 50,000 or 50% of the account balance, whichever is less. Likewise, the maximum loan period is up to 5 years.
Main reasons for not lend your 401 (k)
– If your retirement is very close
– If you plan to quit your job in the coming years or if there are indications of a possible loss of employment
– If it is to cover daily expenses or for items that are not needed as holiday gifts, etc.
– If it is to pay other debts
Remember that the purpose of the 401 (k) is to accumulate funds for retirement; therefore, it is recommended that you consider the loan in case of extreme necessity and as a last resort. First consider other financing options such as credit cards zero or low interest or part of your emergency fund.