Employees are usually unaware but many 401k plans allow borrowing from your 401k account balance. Of course, the primary purpose of a 401k is to fund your retirement but on occasion it may make sense to borrow money from the plan.
Basics of Borrowing from a 401k Plan
- Keep in mind, not all 401k plans allow borrowing as an option.
- Plans may allow as much as 50% of your vested account balance, up to $50,000 dollars.
- Just like any loan, you pay the loan back, with interest, from your paycheck.
- Interest rate is usually set at prime rate plus 1 or 2 percentage points.
- Usually, you have up to 5 years to repay your loan, or longer if funds used for principal residence.
Advantages of Borrowing from a 401k Plan
- It is convenient. No credit check or credit application form.
- Low interest rate compared to other types of loans or credit card interest rates.
- No restrictions; you can borrow the money for any reason.
- You paying interest to yourself, instead than a bank or credit card company.
Disadvantages of Borrowing to 401k Plan
- Opportunity cost of earnings lost while borrowing the money.
- Reduction in the amount you contribute to 401k plan as you pay back the loan.
- If you quit working or change employers, the loan must be repaid back immediately. If you can repay the loan, it is considered defaulted, and you will be taxed on the outstanding balance, including an early withdrawal fee of 10% if you are not at least age 59 1/2.
Things to Consider
- Borrow from your 401k plan as a last result because borrowing will set you back meeting your future retirement goals.
- Never borrow if you are planning to leave your job within the next couple of years.
- Never borrow if there is a chance you will lose your job.
- Never borrow to time the market.
- Never borrow to purchase some luxury item or pay for a vacation.
Contact us today to help you with your questions in regards to whether it makes sense to borrow from your 401k plan. Manuel A. Martinez is a CERTIFIED FINANCIAL PLANNER™ focused on helping families and small businesses in the Charleston and Mount Pleasant South Carolina area.