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Taking Loans From 401k Plans

CPA Chris Gamble talks about the pros and cons of the decision.
CPA Chris Gamble sat down with Ali Touhey on News 8 at Sunrise to discuss the pros and cons of taking out loans from 401k plans.

Gamble says 401(k) Plans are popular retirement savings vehicles that allow employees to take a portion of their salaries and contribute pre-tax to an investment account for retirement savings.  Many plans allow for employees to take a loan from their account; however it is important to understand the loan rules for your company's plan as they can differ from company to company. The actual loan is like any other loan you would get from a bank - there is a loan agreement document, an interest rate and a repayment schedule.

Assuming the 401(k) plan allows loans, employees typically make the request for a loan through their Human Resources Department or the Plan Administrator.  The application process is often very simple and can be processed quickly; many times the loan proceeds can be received in two weeks. Most plan loans are limited to 50% of the employees account balance or $50,000, whichever is less.  In addition, most loans must be paid back in 5 years. 

Some of the pros of a 401(k) loan are:
Convenient - there is no credit check and the application process is short

 Low interest rate - 401(k) loan interest rate are often lower than commercial banking or credit cards and usually carry an interest rate of 1% over the prime interest rate.

You pay the interest on the loan to your own retirement account, so you are adding to your retirement account.


Some of the cons are:
Many loans have upfront fees, often times in the $100 range

The interest rate you are paying back to the retirement plan can be less than the return your retirement assets would have if they were invested in the stock market

If you default on the loan, the unpaid balance becomes taxable and subject to Federal and State income tax and possibly a 10% Federal penalty.

You have to pay back the loan with after-tax dollars.  So if you have a $100 loan and you are in a 30% tax bracket, you will need to earn $130 to pay back the $100 loan.  In addition, when you withdrawal the interest you paid back, it will be taxed a second time.

If you separate employment, either through leaving on your own or by being let go, the loan typically has to be paid back in full in 60 days.

For more information on 401k plans and plan loans, visit the 401k help center or click here.

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