Borrowing Money from Your 401k

If you are thinking about borrowing money from a 401k you need to consider all of the facts. There are times when this may be a good idea, but also situations in which it is a big financial mistake. No matter where you stand on this matter, it is important to know the process for borrowing from your 401k so that you will have a better understanding of what needs done. The most common reasons for borrowing money from a 401k include: buying a home, going back to college or paying medical bills.

The Process

Borrowing money from your 401k may sound like a good idea, but remember that you need to pay the funds back on time. As long as you maintain employment and continue to make payments, you will be able to avoid penalties and fees. If you lose your job at anytime and cannot make payments, the loan that you took will be included in your tax liability.

The first step in the process is to get in touch with your 401k administrator. You need to know the details of borrowing from your 401k, including how it will affect you now and in the future. The federal government has a $50,000 cap on the amount of money that can be borrowed per year.

The repayment plan for a 401k loan is usually five years. However, there are certain types of hardships that may allow you to receive a longer repayment term. If you want to apply for a hardship, you will have to determine if you qualify under the conditions of your plan as set forth by your company and 401k provider.

Drawbacks

There are a few drawbacks of borrowing money from your 401k. The number one argument against this is that you are reducing the rate at which you are saving money for retirement. Since you have less money in your account, you are earning less interest. Along with this, most plans have a stipulation that you are not allowed to make additional contributions until a particular percentage of the loan is paid back.

If you are unable to pay back the loan for any reason, due to a job loss or any additional financial trouble that you were not expecting, your money will be taxed. If you are unable to make the payments, the IRS will consider this a taxable withdrawal – this means that the money will be subject to income tax. In addition, you will also have to pay a 10 percent early withdrawal fee. If you have doubts that you will be able to pay back the loan, avoid borrowing your 401k funds.

The process for borrowing money from your 401k may be simple, but there are many drawbacks to consider before you withdraw your money. Keep in mind that everything you borrower is less money for you at time of retirement and you can be placing your security in the future at stake.

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