How Best to Evaluate the Pros and Cons of a 401(k) Loan

When evaluating loan options, there are a number of elements to consider. Bank. Credit Card. HELOC. Refinance. 401(k). Although the 401(k) loan is likely easier, it’s critical to consider the costs of this alternative, as well as potential problems such as taxes and penalties on withdrawals from your 401(k) as a loan.

THE PROS OF A 401(K) LOAN

Logistical Ease:

A 401(k) loan typically involves completing a short form your HR department will provide. No explanation pertaining to how/what the money is for. No requirement for a credit check. Eligible to borrow up to half of your 401(k) plan balance to $50k. Note: some employer plans may establish lower limits.

Repayment Terms:

Repayment terms tend to be extremely attractive. Any interest paid goes to you, with the total payment going back into your 401(k) account. The employer likely provides lower interest rates.

Ease of Payback:

It’s automatic and systematic. The amount of loan repayment is taken from your paycheck every pay period. No concerns with late charges or missed payments. The money is never seen.

THE CONS OF A 401(K) LOAN

Loss of Growth:

The investment growth that the loan principal would have generated if you had left it in the account is lost.

Higher Return:

The interest paid back will boost your balance to some degree, HOWEVER, the long-term average returns on investments should be higher.

Double Tax:

You have to use after-tax money to pay that interest, which will potentially be subject to tax again at retirement.

Employer Tie-In:

A 401k loan is tied to your employer. If you quit, are fired or retire, your 401(k) loan will immediately come due. You will have ONLY 90 days to repay the entire principal balance.

Possible Penalties:

If the above timeline isn’t met, the IRS will treat the loan as a withdrawal from your retirement plan. As a result, taxes are due on the amount of the loan that you couldn’t repay. Also, the loan is subject to penalties of an additional 10% if you are under age 59-1/2 and don’t qualify for any of the exceptions.

SHOULD YOU TAKE A RETIREMENT PLAN LOAN?

Make certain to evaluate the following factors: the purpose of the loan, expected return on investment within your retirement plan, your tax rate, loan cost, impact to future wealth and potential penalties. Contact your plan administrator for details on the loan and withdrawal options available to you.

Make sure to coordinate this decision with your advisor as there may be planning considerations to evaluate. Ideally, you’ve developed a comprehensive plan covering short, medium and long-term goals and utilizing a 401(k) loan won’t be necessary.

If you would like to learn more about this subject or receive a free quote then please contact us and we’ll be happy to help.

 

Securities and investment advisory services offered through NEXT Financial Group, Inc. Member FINRA/SIPC. None of the named entities are affiliates of NEXT Financial Group, Inc. Neither NEXT Financial Group nor its Representatives give tax or legal advice.