The good, the bad and the ugly
401(k) loans offer you access to your account funds. They offer peace of mind, that in an emergency
you can access these monies without any tax penalty to get through a tough time. That said, it's important
to know how it works and the potholes that can throw a big monkey wrench in your finances both today
and down the road.
You can get a loan from your 401(k) for up to 50% of your vested account balances (your personal contributions
plus any vested matching or profit sharing from your company) with a cap of $50,000.
You pay yourself back at a rate of Prime plus 1%. That's a pretty good rate! Loans are put on a schedule
to be paid back over a 5 year period. If you have employees, then payments will be automatically deducted
from payroll. There is one exception, which is a residential loan. These can be paid back over 30 years.
Most plans restrict how many loans you can have outstanding at any one time. With ShareBuilder 401k,
we allow 1-2 loans per participant. The cost to start your 401(k) loan is typically pretty nominal.
Your retirement saving goals will likely suffer. The money you take out for a loan will not have the
opportunity to grow with your investments. This means it will probably take longer to reach your savings
You pay the loan back like any loan with your after-tax income and when you do withdraw the monies in
retirement, it will be taxed again. Yet, the monies do grow tax-deferred once back in your 401(k) account
until used in retirement and you won't have that option with other loan types.
If you quit or lose your job, the outstanding 401(k) loan amount is due fairly quickly, typically within
30-90 days. If you do not pay off the balance within this time, Uncle Sam treats this as a 401(k) distribution
and you will be taxed at your current tax rate plus a 10% early distribution penalty on top of it!*
If you do not make payments to your 401(k) loan for 90 days, again Uncle Sam will be unhappy and treat
this as a 401(k) distribution. And that means it will be taxed at your current tax rate plus the 10%
Our take on 401(k) loans
Our vision is to lead Americans back to saving — and loans are not a savings
tool. If you are considering a loan given your personal situation, make sure you consider your company's
soundness and your job security. Having to come up with a big lump sum to pay back the loan if you were
to be out a job isn't easy. Or worse, being hit with taxes and penalties is truly a big hit to saving
and your finances. We always suggest starting with your bank and then consider your other options before
tapping your 401(k).
401(k) loans do offer peace of mind, convenience, and low rates, but the pitfalls that exist truly make
them an emergency source of funds. If you do take a loan, put a plan together that enables you to pay
the loan back as quickly as possible so you lower your risk to the "ugly" and stay on track to meet
your long-term goals.