Although the IRS generally allows loans to be taken out from 401 (k) plans, your employer may not allow it in their particular plan. If your employer allows you to borrow against your 401 (k) balance, there may be other restrictions. Loans for your 401 (k) cannot exceed the lesser of 50 percent of your acquired balance or $ 50,000 and they must generally be repaid within 5 years. In addition, employers can impose restrictions on the purpose of the loan. For example, some employers will only allow loans for unpaid medical bills, education fees, first-time buyers, and financial hardship. Be sure to check with your company or your company’s 401 (k) plan administrator to confirm if you can borrow money on your 401 (k) and, if so, under what terms. Apart from these restrictions, you should keep in mind that there are pros and cons to borrowing from a 401 (k) plan.
The main benefits of borrowing from your 401 (k) plan include:
* No Credit Check – If your business authorizes the loan, it is usually easy to qualify without having to go through a credit check;
* Lower interest rates – The interest rates with which you repay loans are generally more favorable than the rates for commercial loans;
* Interest is paid back to your account – You pay the loan yourself instead of paying a bank or credit union;
* The loan proceeds received are not taxable – The loan you receive is not considered taxable income unless you are in default on the loan; and
* No Early Withdrawal Penalty – As long as you are not in default on the loan, you are not subject to the 10% early withdrawal penalty if you take out a loan before age 59.5 years.
The main disadvantages of borrowing from your 401 (k) plan include:
* Loan must be repaid – If you lose your job or leave voluntarily, you will usually have to repay the loan in full, immediately, or be subject to income tax on the unpaid balance and a premature distribution penalty of $ 10. %;
* Repayment is made with after-tax dollars – Every dollar you earn to pay off the loan will have income taxes taken. That same dollar will be taxed again when you retire and withdraw your money from 401 (k). For example, if you are in the 25% tax bracket and you earn $ 100. After income taxes are taken on that $ 100, you will have $ 75 left to pay off your loan. That same $ 75 will be taxed again when you retire and withdraw the funds as a distribution; and
* Lost Opportunity – By reducing your 401 (k) balance, you lose the potential for that money to grow and earn interest in the long run.
In general, taking out a loan from your 401 (k) is not a good idea for most people and is not widely recommended. However, in some circumstances this may be the only possible option available. Keep in mind that 401 (k) plans are set up with incentives to encourage people to create and maintain long-term savings for retirement.