Should You Take Out A Loan From Your Retirement 401k Plan?

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In 2022, most people need more savings to retire at the standard age. Luckily, we live in a time when there are more options than ever. One of those options is taking out a loan from your 401k plan. Just keep in mind that these loans come with their own set of pros and cons.

If you have an unforeseeable need for cash but can’t get it anywhere else, you might be able to take out a loan from your 401k plan. Just remember that it’s not free money – loans from your 401k or similar plans come with strings attached. Here are some things you should know about taking out a loan from your retirement plan before you decide to do so.

What Is A 401k Loan –

A 401(k) loan is essentially the same as a personal loan, except that you borrow from your retirement account instead of a bank or other financial institution.

The interest rate on a 401(k) loan is usually higher than that on a personal loan, and borrowers must pay back the money within five years. In addition, the company usually charges an origination fee that manages your 401(k).

The loan must be paid with interest by making monthly payments or reducing your plan contributions. You should also be aware that if you default on the loan, your employer might be able to recoup some or all of their investment in the plan.

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Advantages Of Borrowing From Your Retirement 401k Plan –

There are a few advantages to taking out a loan from your retirement plan, but the most important is that you won’t be paying interest. While this may sound like a small detail, it can make all the difference in paying off your debt.

When you pay interest on your debt, there will be less money left over for you to use toward withdrawal. If this is the case and interest is eating up most of your available funds, it might be worth taking out a loan from your retirement plan.

Do you have an emergency fund in place and can pay off the loan before any payments are due? Taking out a loan from your retirement plan might not even be necessary. If you want to take out a loan from your 401k plan just because you can, then consider what would happen if that emergency came up and you couldn’t pay back the money owed on time. You would likely have to choose between paying back the money owed or paying the loan back.

Many benefits exist for taking out a 401k loan, which is why many people decide to take such loans shortly after they become eligible to do so. One of the benefits of taking this type of loan is that there is no lengthy application process. Traditional loans can take up to two or four weeks before the applicant even receives approval or denial on the request. A 401k loan can be processed within days.

Another benefit of a 401k advance is that the interest rates are much better than those of traditional personal loans. In addition, a 401k loan does not require a credit check to receive because the money is yours. Therefore, all borrowers should get approval for the funds that they need in a short amount of time. You should have no problem hearing a positive answer from the lender.

Risks Of Taking Out A 401k Loan –

The 401k loan idea does have some disadvantages to it. The first disadvantage is that there are some restrictions when it comes to repayment time. You will have to repay the advance rather quickly if you use the funds to buy something like a car.

Secondly, you lose some of the money that goes towards your requirement when you borrow from the 401k. Furthermore, you end up having to pay back more than you borrowed, but a certain level of that happens with regular cash advances, as well. The decision of whether or not to take this type of loan must be yours and yours alone. If you can find some other means to get the funds, that would probably be the best solution.

Borrowing from your retirement 410k plan has some drawbacks you should be aware of. Let’s discuss some of those negatives now:

  1. You’ll Have To Pay It Back More Quickly

You’ll have to start paying back the loan when you leave your job. You’ll be required to pay it back within a certain time – usually five years. If you leave your job after that period, you’ll have to pay an additional penalty for the interest you owe.

  1. You Could Pay Taxes And Penalties

There is a good chance that you’ll pay taxes and penalties on the loan. The exact amount differs from plan to plan, but you can expect to pay at least 10% of the amount borrowed. This could be as much as 25% if you have a high enough income.

  1. You Have Limits

Like a credit card, you can only take out a maximum amount of money from your 401k plan. This is usually set at $50,000, but it depends on the type of loan you are taking out. If you take out a short-term loan, there sometimes is no limit to how much you can borrow.

The High Cost of a 401k Loan –

If you are a hard-working person that has an emergency, a new business venture, or a large purchase that you desire, you may be thinking about borrowing from your 401k plan. Generally, people can borrow money from their 401k plans after a certain amount of time if they have the minimum amount of money in the account that is necessary to take out a loan.

The time may be one year from when the person opens the account, and the amount may be several thousand dollars. Employees should request that information from their employers as soon as possible. Each person should weigh the pros and the cons before deciding whether or not to take out a 401k loan.

When times are tough, and money is tight, it may be tempting to dip into your 401k to take out a loan to get you through a rough patch and back on your feet again. Taking out a 401k loan may sound like a viable option; after all, the money is yours, right? However, there are several things you may want to consider before taking out the loan.

How to Get a 401k Loan –

To request a 401k loan, you will have to log into your 401k client account online. You will have to state the reason for the request. The companies are usually fair about situations such as eviction prevention, medical needs, vehicle or home purchase, and educational expenses. The educational expenses are monies that you would have to pay so that your children can go to college. The menu option should be available so that you can ask for the loan if you qualify for it. If you are approved, you will receive your check in the mail. You can then do whatever you please with the funds. If you are not comfortable with applying online, you can always give the company a call and ask about how to request a loan from your 401k.

The Slippery Slope –

Though you may intend to pay the money back into your fund, depending on the circumstances, your loan could very easily turn into a withdrawal. For instance, if you lose your job, you may be required to repay your loan quickly, in which case what you originally intended to be a loan will become a withdrawal. Once your loan becomes a withdrawal, you will have to pay both taxes and penalty fees on the balance you owe, and it doesn’t stop there. Approximately every one thousand dollars withdrawn for people in their 30s will cost around ten thousand dollars in lost future income. For people in their 20s, the number is even more staggering at 20 thousand dollars lost because you are not contributing to the investment anymore.

Even if your loan does not become a withdrawal, it could stand in the way of future contributions. Whether you voluntarily stop because you can’t afford to make contributions while you repay your loan or whether your plan has prohibited you from making contributions, it will cost you. Once you stop contributing during your loan period, you can lose anywhere from ten to twenty percent of your future retirement fund. If you are able to continue contributing, you will likely be contributing less than if you had not taken out the loan.

Consider All of Your Options –

Before taking out a 401k loan, ask yourself if it’s really necessary. Is the loan for an emergency, or is it for a vacation or other luxury? Is there a bigger financial problem at hand that you should be focusing on? If so, consider cutting unnecessary expenses first before taking out the loan. Can you keep up with your monthly contributions if you take out the loan? If not, you may want to reconsider and find a different option.

Conclusion –

Taking out a loan from your 401k plan should not be taken lightly. You should research and make sure it is the right decision. You should also pay attention to any restrictions on how much you can borrow. Finally, look at the total cost of the loan and the interest rate.

If you are struggling financially, a 401k loan is not your only option. The professionals at AdvantageCCS can help evaluate your financial situation and offer a variety of options and services to get your finances in order while making sure your financial future remains secure. We can work with your creditors to help you make manageable payments based on your current income and budgeting situation. We can work out a Debt Management Plan and help you learn to stick to a budget. Don’t potentially damage your future savings; try contacting us first!


Disclaimer: The information provided is for informational purposes only. The materials are general in nature, and are not offered as advice or guarantee, and should not be relied upon without advice from an attorney or a financial advisor. Reading the information does not constitute a legal contract, consulting, or any other relationship with Advantage Credit Counseling Service.
Author: Lauralynn Mangis
Lauralynn is the Online Marketing Specialist for AdvantageCCS. She is married and has two young daughters. She enjoys writing, reading, hiking, cooking, video games, sewing, and gardening. Lauralynn has a degree in Multimedia Technologies from Pittsburgh Technical College.