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| Yes | 23% | 12 votes | Total: 53 votes | |
| No | 77% | 41 votes |
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Add to FavoritesWhether borrowing from your 401 (k) plan is a wise decision or not depends upon your circumstances, but it can often be a wise decision provided you have considered all the pros and cons of such borrowing, know how to plan for it and are able to repay it in time.
FIRST KNOW ALL THE DETAILS OF YOUR 401(k) PLAN
The primary purpose of 401(k) plan is to plan for your post-retirement life. In addition it also provides you certain tax benefits and often a matching contribution from your employer. Before deciding to borrow, you must know all about the terms and conditions. While doing so, make note of the following factors.
(i) First of all confirm the availability of borrowing option. Next, find out the maximum amount you can borrow. Usually, it is an amount that is lesser of 50% of your vested balance in the 401(k) plan or $50,000. Compare this will your actual need. Borrowing from 401(k) would be worth only if it able to sort out the credit crunch you are facing.
(ii) Ensure the time limit for repaying loan. Usually the maximum time limit allowed for repaying this loan is up to five years, except in the case you need it for your first home mortgage, when it is up to fifteen years. Try to assess your overall financial position and future obligations and see whether you would be able to make the full repayment in prescribed time. This can have significant impact because if you are unable to repay the loan in prescribed time, your borrowing will be treated as a premature withdrawal and attract income tax as well as a penalty of 10% on the amount borrowed.
(iii) Take in to account any matching contribution from your employer in your calculations. If there is a provision of a matching contribution from the employer, then it would be usually preferable to continue with making contributions even during the period of repayment of an earlier loan, in case terms and conditions of your plan allow for that. In case this is not allowed, or if you may not be in a position to make fresh contributions during repayment, then the actual cost of borrowing will be higher than the rate of interest.
COMPARE ALL THE OPTIONS FOR BORROWING
One must always remember that 401(k) plans are meant primarily for a purpose other than tapping into for debt. Thus, other more regular option for borrowing must always be considered, including paying your taxes in instalments. However, in case your credit worthiness does not allow you to take credit from financial entities, or the only options available are high risk, high cost ones like a credit card, or if they do not allow you enough time to save and repay, then borrowing from your 401(k) plan could be a very sensible step.
ANLYZE ALL THE PROS & CONS OF BORROWING FROM 401 (k) PLAN
PROS
1. Getting the loan from your 401 (k) plan is usually a simple and expedient process, not requiring cumbersome formalities or procedures. You can get the loan irrespective of your past credit rating.
2. The interest rate charged is usually low compared to other credits.
3. So far as you pay it back, there are no taxes or penalties for borrowing.
CONS
1. Borrowing from 401(k) restricts your earnings to the interest paid by you and if you cannot make contributions you may lose out on matching contributions of your employer. In addition, it can disturb your whole retirement planning.
2. There is always a danger of not being able to repay within the stipulated time, leading to imposition of income tax and an early withdrawal penalty of up to 10%. Even in case you lose your job you would most likely be required to repay the debt within 60 days failing which it may be considered as an early withdrawal with all its adverse consequences.
TAKE A DECISION AFTER ANALYZING ALL THE FACTORS
Once you are aware of all the relevant factors, you can take a decision regarding borrowing from your 401(k) plan. You must also assess the need for borrowing. Casual borrowing for a consumer durable which is not exactly unavoidable may not be a wise step, however, borrowing to keep off loan sharks, or to buy a house would always be worth it, as would also be occasional borrowing of a manageable amount to repay very high interest credits as in the case of a credit card. While taking this decision, you need to be reasonably assured about not likely of losing your job, or shifting it to some other employer, as well as your future incomes and repayment capacity. It is also worth remembering that funds in retirement plans are comparatively safe from pending debt claims.
A WISE DECISION
A wise decision to borrow from 401(k) plan would be one where there is no marching grant, the need for funds is absolutely unavoidable, other credit options are either not available or costing a very high rate of interest, and you are reasonable assured about the continuity of your career till the time the amount borrowed from 401(k) plan is repaid. It would be even wiser if you are replacing the safety of your retirement plan with a house property being purchased with funds borrowed from 401(k) plan.
Learn more about this author, V. Kumar.
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No
It is NEVER wise to borrow from your 401k unless it is to keep you from getting your house foreclosed on.
Why is it so unwise?
1) You are losing the interest that the money in your 401k would be earning if it were still in your account. You can easily average 10-12% interest in any decent 401k. You are paying yourself back at maybe 5-6% so you are still losing ground.
2) The interest rate/expense paid is not tax deductible.
3) Most 401k loans must be repaid in 5 years or less.
4) 401 plans can charge loan fees and annual service charges.
5) You are limited to loans of either 50% of your 401k balance or $50,000 which ever is smaller.
6) The interest rate that you are paying yourself will be similar to the interest rate you can find at a bank or credit union.
7) You are also putting yourself at risk because if you should ever lose the job you have when you take your 401k loan, you will have 60 days to repay it in full or be penalized. It will be as if you made a withdrawal from your 401k so you would have to pay a 10% penalty on the initial loan plus you would have to pay taxes on it.
Just for fun let's run some calculations. If you have $100,000 in your 401k and you leave it sit for 5 years averaging 12% interest. You will have about $176,200 in that account. If you withdraw $10,000 and pay that $10,000 back at 6% interest over 5 years, that same account will have $175,100. You just lost $1,100 not to mention the fact that you had to pay $10,000 back in just 5 years.
Using our example, if you were to lose your job, you would have to pay $1,000 in penalties plus probably around $1,000 in taxes. Now you would have lost your job, you would still owe on the loan, and most likely you would not have any money. You would have to come up with $2,000 plus whatever the balance is that you owe on your loan. Where will you find that money? Maybe you could get a loan from a bank or credit union. But now you don't have a job so that may be difficult. You could have saved yourself a lot of headaches and some money by simply going to a bank or credit union to start with.
In my opinion you should never take out loans except for your mortgage, but if you are going to take out a loan go to a bank or credit union. NEVER borrow from your 401k unless it is to stop your house from being foreclosed on. And even then there are other avenues that you should use first such as doing a short sale.
Learn more about this author, Art West.
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