401k And Ira
Essentail Considerations For A 401K Loan
A 401K loan is an effective form of short term financing for individuals who needs to get access to funds. 401K loans are allowed by law although 401K borrowing is not always provided by employers. The cost of adding this feature to the plan is sometimes prohibitive to some small businesses. In theory, the concept of taking a loan against 401K should be simple. After all, it's your money and the interest and principal you pay goes back into your 401K account.
When then, is a 401K a good solution? The basic stipulations of 401K borrowing allow you to borrow up to 50% of your account balance up to a balance or $50,000, whichever is less. You are usually required to pay this back within a period of 5 years, unless it's for a 401K mortgage for your first home in which case you have a longer payback period. There is some prudence you need to exercise when making this decision. A 401K hardship withdrawal is a valid approach so long as it is not a distribution. There is a 401K penalty on early distributions.
The statues that govern 401K loans do not place any restrictions on what the money can be used for expect that the loans must be made reasonably available to all individuals. In reality, an employer can restrict the reasons for loans. In some businesses, loans are restricted for the purposes of preventing home eviction, paying educational expenses, paying medical expenses or for the purposes of buying a first time residence. Most employers offering 401K loans will restrict the number of loans. Generally, the loan amount is deducted from the paycheck each week and the loan interest rate is set at the prime rate plus 1%.
There are many advantages to borrowing from 401K loans. There is no need to go through credit checks and the application process is minimal. You will automatically be entitled to the loan provided it is within the established guidelines. When you pay back the interest you are effectively paying yourself and the interest is tax sheltered. You don't pay interest on the loan until retirement.
There are other factors to consider for 401K loans. If you are planning to leave employment, often the unpaid loan will be distributed as income. The amount could then be subject to income tax and you could suffer the 10% 410K penalty. Another factor to consider is that you can be effectively losing interest. Payments to satisfy 401K loans come from after tax dollars and any amount you contribute to the loan has an opportunity costs associated with lost investment or interest earning activity.
You should examine the options before you jump at 401K loans. They may not always be the best solution. It is prudent to consider all the angles and know all the implications before you borrow from 401K.