Should You Borrow From Your 401(k)?
Should You Borrow from Your 401(k)?
Given the current interest rate environment, it may be tempting to consider taking a loan from your 401(k) as a source of financing your needs or wants. Assuming your employer plan permits borrowing, be sure to review the impact on your overall financial situation and retirement savings before taking out a loan. Here are some advantages and disadvantages to bear in mind:
Pros:
- No Credit Check or Application Process: Unlike traditional loans, 401(k) loans typically do not require a credit check since you're essentially borrowing from your savings. However, if you’re married, some plans may require spousal approval.
- Availability: Funds are readily accessible and already sitting in your account. The IRS limits borrowing to the lesser of 50% of your vested account balance or $50,000.
- Straightforward Repayment: You typically have up to five years to repay the loan, and the repayments are usually deducted directly from your paycheck. You may qualify for a longer repayment period if you use the funds to purchase a primary residence.
Cons:
- Negative Impact on Retirement Savings: When you take a loan from your 401(k), the borrowed amount is temporarily removed from your investment portfolio, potentially hindering the growth of your retirement savings, and causing you to miss out on potential market gains.
- Default Consequences: If you fail to repay the loan according to its terms, the outstanding balance could be treated as a deemed distribution, subjecting you to income taxes and potentially early withdrawal penalties if you are under 59½.
- Changing Jobs Triggers Repayment: If you leave your employer or are laid off, the outstanding loan balance usually needs to be repaid within a short period (i.e. 60 days). If you can't repay it, it will be treated as a deemed distribution, subject to taxes and potential penalties.
Other Considerations:
- Interest Earned: Like other loans, you will have to pay interest on the borrowed amount (rates are typically around the current prime rate), but luckily for you, this interest will be paid back into your 401(k) account. However, understand that when you pay that interest, it will be paid with after-tax dollars and then in the future when you take withdrawals in retirement, that money will be taxed again.
- Penalty-Free Withdrawals: Outside of a loan, you can consider taking a withdrawal directly from your 401(k). While you will have to pay income tax on any pre-tax distributions, you may be able to avoid the 10% penalty on early withdrawals if you are under 59 ½ if you qualify for certain exemptions such as natural disasters, domestic abuse, or health issues.
As always, be sure to consult with your financial advisor to fully understand the implications of taking a 401(k) loan as it relates to your individual situation.
Resources:
https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-loans
https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-loans#return
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through WCG Wealth Advisors, LLC a Registered Investment Advisor. The Wealth Consulting Group and WCG Wealth Advisors, LLC are separate entities from LPL Financial. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This information is not intended as authoritative guidance or tax advice. You should consult with your tax advisor for guidance on your specific situation.
Traditional IRA account owners should consider the tax ramifications, age and income restrictions in regards to executing a conversion from a Traditional IRA to a Roth IRA. The converted amount is generally subject to income taxation.
The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.
