When it comes to borrowing money from your 401(k) loan, you need to know several things. You can only borrow from it if the company that you are currently working for offers the plan.
Even in this instance, not all companies will allow you to borrow from your 401(k), which means that you should check the rules of your plan to see whether it allows for loans.
Here are the pros and cons of borrowing from your 401(K):
Pros of Borrowing from Your 401K
– No minimum credit score is required
– No loan application is necessary
– You can repay the loan with automatic paycheck cuts over a period of up to five years
Cons of Borrowing from Your 401K
– If you quit your job before you finish repaying your loan, the outstanding balance will be treated like a taxable distribution unless you finished repaying within the specified amount of time.
– The money in your 401(k) is protected from bankruptcy and creditors, which means that if you borrow to repay your debts then end up filing for bankruptcy anyway, you will have misused your money.
– You will start paying double taxation in terms of interest
Reasons to Take out 401(k) Loans
People usually borrow from their 401(k)’s for these reasons:
– To pay off other debts
– To fund a startup business
– To buy a vehicle
– To help relatives
Americans are borrowing too much from their 401k’s, and this is not a good idea. When you borrow from your 401(k), you are hurting your future savings for retirement and missing the compounding interest. Before you use up your retirement savings, you should think long and hard.
Who Should Borrow?
Because the money in your 401(k) is protected from creditors, you need to think carefully before deciding to borrow it, as this gets rid of the protection. Make sure that you explore all the possible options before deciding to mess with your retirement savings. If you feel that your current job is secure and you know how to manage money well, a 401(k) loan might be an acceptable option.
If you are a businessperson, you can borrow from your retirement savings severally and repay the loan. Doing so will help you to fund the acquisition of a different business venture. The success of borrowing from your 401(k) hinges on understanding the clause for repayment and repaying the loan on time.
Who Shouldn’t Borrow from a 401(k)?
People who have many debts should avoid borrowing from their 401(k)’s because if they end up filing for bankruptcy, they will also lose their retirement savings. If this loan does not solve your debt problems, you will not be solving anything; in fact, you will have made things worse for yourself.
If you end up losing your job and without the ability to repay the loan, you will owe money to the IRS for income tax and penalties.
Alternatives to Borrowing from Your 401(k)
Some 401(k) plans allow for a hardship withdrawal if you run into unexpected problems such as medical emergencies or you want money to prevent an eviction. If you borrow money for a hardship withdrawal, you will have to pay taxes on it for that year. If you are deep in debt, you should get in touch with your creditors to work out a plan for repayment.
Moreover, if you cannot repay your debts, you can speak to a bankruptcy lawyer to find out if you can file for bankruptcy to erase your debts while retaining your 401(k).
As you have seen, borrowing from your 401(k) is not something that you should take lightly because it has long-lasting implications.
About the Author
Joseph Hogue is a financial expert and investment analyst. After serving in the Marine Corps, he started his career investing in real estate before becoming an investment analyst for some of the largest private investors. He's appeared on Bloomberg and on CNBC as an investment expert and has published ten books in personal finance. Now he helps investors reach their financial goals and invest in the stock market with some of the same advice he used when working for the rich.