Many 401k members see their growing pension accounts as a tempting supply of money. Fidelity’s Quarterly Retirement Snapshot sums the average 401 (k) plan balance at the end of 2014 to $ 91, 300 while long-timers who have been stuck for over 10 years have an average balance of $ 248,000 with their 401k.
consumers, their 401 (k) assets can exceed the amount of all their other financial accounts. (For related information, see: 6 Problems with 401 (k) plans. )
The interest rates on a 401 (k) loan are low – sometimes 1-2% above prime – and the interest is repaid to your own account. Borrowers love these loans because they are not taxable withdrawals. The low interest rates tempt participants to borrow from their 401 (k) on other options with higher interest rates such as credit cards or bank loans.
Another advantage of borrowing a 401 (k) are the loopholes in the repayment. Under certain conditions, reimbursements can be suspended, for example when you perform a military service or if you take leave for less than a year. However, these terms and conditions do not relieve your repayment responsibility. They are only a temporary interruption of the reimbursement.
How much can you borrow?
According to IRS. gov, there are certain parameters for 401 (k) loans. If your company allows loans from the 401 (k) plan, there are limits to the loan amount. (For related information, see: Can I buy my 401 (k) to buy a house? )
The IRS determines that the maximum loan amount is “the largest of $ 10, 000 or 50% of your acquired balance, or $ 50,000, whichever is less.” So if your 401 (k) account balance is $ 30,000, then the maximum loan amount is $ 15,000.
The loan must be repaid within five years with equal principal and interest repayments with at least one payment per quarter. You may also be able to repay the loan over a longer period if you use it to purchase your primary home.
The 401 (k) Loan’s Upside
If you come across unexpected costs that you intend to pay back quickly, consider borrowing from the 401 (k) account. In most cases, the borrowing process is fast. You fill in a simple form and you have access to your money within a few days. Unlike other loans, because you borrow your own money, a credit application is not required. This means that the loan has no influence on your credit history or score.
Your interest payments are refunded to your own account, not to a lender. The loan repayments can be made via wage deduction and as mentioned earlier, the rates are low. (For more: Can I use my 401 (k) as collateral for a loan?)
The risk of a decline
Just because you can take out a 401 (k) loan. It means that you should. Don’t forget that this savings account is gradually growing and merging for your future pension. Money that is not in the account – it is used for other purposes – does not snowball to provide you with a safe pension.
If you borrow from the 401 (k) discretionary costs, such as renovating a house or a new car, you have to think long and hard about what you give up by withdrawing the money from the account. Imagine withdrawing $ 50,000 from your retirement account for three years. If the stock market rises by 9% in each of those years, you have lost $ 14, 751 in potential investment returns. ($ 50,000 grows to $ 64, 751 in three years with an annualized return of 9%.)
So what happens if you do not repay the loan?
If you take the money out of a 401 (k) plan before the age of 59 and you do not pay it back, you will be hit with a double fine. You owe 10% to the withdrawal plus income taxes. That is a good idea. Phenomenon-rich fine for money that can be aimed at a comfortable pension.
The bottom line
The 401 (k) loan is money ready to borrow, and it’s yours. But if you retire for use today, your own Infirmary is punishing your future self. You lose the capital gains, dividends and interest that the account would otherwise have earned. If you choose not to repay the loan at all, you charge yourself heavy taxes and a fine. In short, you should treat a 401 (k) account as untouchable until your retirement and work hard to build up an emergency fund to pay for unexpected expenses. (For more: How to calculate penalties in a 401 (k) early withdrawal?)