While taking a loan from your 401(k) is certainly frowned upon by most financial advisors, there are certainly some occasions where even the most stringent of advisors would give you a pass. It’s not recommended, but financial hardship does come knocking and your 401(k) could help soften the blow; it could also come to the rescue should a car desperately need to be purchased, a home, or if substantial, and expensive, repairs need to be done on your home. You can find out how much super you need to retire by checking out the new Suncorp site.
Regardless of the reason why you’re considering borrowing from your 401(k), there’s a lot for you to consider before to dive into the deep end with your retirement savings. Below, I’ve compiled a list of commonly asked questions, or simply questions that should be asked, on the subject of borrowing from one’s own 401(k) to assist in your decision.
Q: Will my employer allow me to borrow against my 401(k)?
A: It completely depends on your employer and the plan that they have in place for their 401(k) program. You’ll need to contact your plan’s administrator to find out what the ins and outs of the plan are and see what stipulations they place upon loans – for instance, some employers only allow loans in the case of extreme financial hardship.
Q: How much can I borrow from my 401(k)?
A: There will almost never be a case where you’ll be able to borrow the entirety of your 401(k), but generally, you can expect to be able to take $50,000 or less, or one-half of the vested plan benefits – whichever happens to be less. However, if your account only has $20,000 to its name, your borrowing power will be capped at $10,000.
Q: Do I have to repay this “loan”?
A: Yes, of course; it’s a loan and just like any other loan, it needs to be repaid or you’ll face penalties. For a 401(k), you typically have around 5 years to make good on the loan and are required to make regular payments to cover both the principal and the interest quarterly. An exception would be if you used the funds to purchase a home; in this case, you would be allotted more time to settle the loan.
Q: What happens if I don’t repay the loan?
A: It’s highly important to repay all loans borrowed from your 401(k) in the exact manner that it calls to be repaid. If you don’t follow through on repayment – and are under the age of 59 ½ — the loan amount will be marked as a taxable distribution and you’ll be saddled with a 10% federal penalty tax; this is in addition to income tax on the outstanding balance.
Q: Are there any advantages to borrowing money from my 401(k)?
A: There sure are, but only if you repay the loan. As long as the loan gets repaid in full, you’ll enjoy taking out a loan that is tax and penalty free – all for the same competitive interest rates as banks that offer similar loans. However, instead of those interest rates going to the bank, you’re simply paying them back to yourself – they go right back into your account, since you borrowed against yourself.
Q: What are the serious disadvantages?
A: As mentioned, if you don’t repay the loan, you could face some serious taxes and penalties – that’s the big one. Also, you need to make sure that you’re happy with your job before you borrow. Should you leave your job with an outstanding balance, you’ll only have 60 days to repay the loan in full. Finally, by dipping into your 401(k) early, you’ll lose all tax-deferred interest that may have built up on the funds in your 401(k).