by V. Kumar

Created on: August 20, 2008

Whether 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

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