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401(k) Loans

401(k) Loans

I am frequently asked about the advisability of taking a loan from your employer retirement plan.

Yes, you can borrow from your 401(k). Yes, it is easy money to access.  Typically, the minimum loan amount is $1,000 and the maximum loan amount is no more than $50,000 or 50% of your vested account balance, whichever amount is greater.   Some employer plans will allow employees to have multiple loans outstanding at the same time.  Typically, a general purpose loan must be repaid in 5 years; a loan to purchase a primary residence must be paid back in 10 years. There are loan set up fees, varying from approximately $25 to $100. Some plans will also assess annual loan maintenance fees.  Interest is paid on borrowed amounts.  The interest is typically tied to the Prime rate plus an additional point or two.

So, I have given you all the technical details, here are some other things to consider BEFORE you tap into your 401(k) for a loan.

  • Money withdrawn from the 401(k) is repaid with after tax dollars.  Assuming the loan is made from pre-tax contributions, future distribution of these dollars in retirement will also be subject to taxes.  Effectively you pay taxes on the money two times!
  • Money withdrawn from the 401(k) stops compounding and growing for you, resulting in fewer dollars available for retirement!
  • If you leave your employer, the loan must be paid back.  Failure to repay the loan results in the loan balance being re-classified as distribution.  The distribution amount will be subject to income taxes and if you are younger than 59.5 you will also pay penalties for an early distribution.

Basically, my thoughts on 401(k) loans is that they should be a last resort and not a first resource.

If there is any equity in your home, or if you own permanent life insurance, you can borrow against those assets, instead of tapping into your 401(k).  Using these assets, you can continue to reap the benefits of tax deferred compounding within your employer retirement plan.