The good news is that the economy continues to show signs of improvement and recent research suggests that incomes are beginning to rise. The bad news is that many workers continue to face financial strain and are seeking sources of money to solve pressing financial problems. One source often discussed is the money held in the worker’s company retirement plan. The question is, “What are the pros and cons of taking a loan or withdrawal from my company 401k plan?” Some plans do not allow loans or withdrawals so you should check with your Human Resources department or plan administrator to find out if yours does.
If your plan does allow loans, federal regulations specify that loans cannot exceed the lesser of $50,000 or 50% of your vested account balance. For accounts of less than $20,000, special rules allow you to borrow the lesser of $10,000 or your entire vested balance. Before you rush out to claim your newfound cash, weigh carefully the pros and cons of such a move. Here, we can teach you How to get an unsecured personal loan.
- Getting the loan is easy and there is no credit approval.
- You’ll pay a competitive interest rate and, in fact, you’ll be adding interest to your retirement account instead of a bank or other financial institution.
- By taking money from your plan in the form of a loan, you avoid income taxes and penalties.
- Loans must be repaid in installments over a 5-year period. Failure to make timely repayments may result in ordinary income tax treatment and federal penalties on your loan proceeds.
- If you leave your employer (or are terminated), you must repay your loan within 60 days or face income taxation on the outstanding loan amount. There may also be a 10% federal penalty if you are under age 59 1/2. Typically the money has been spent so the taxes and penalties are a rea threat.
- Loan interest is not deductible.
- You have forfeited tax deferred growth on your loan proceeds. This is a critical factor in your retirement planning.
In addition to loans, the federal government allows withdrawals from your 401(k) plan under certain hardship circumstances. Generally, you are allowed to withdraw the funds from your plan if you can demonstrate that you have a severe financial need that cannot be satisfied through another source. Your withdrawal cannot exceed the amount needed to satisfy the hardship need, including the income taxes on the withdrawals. Typically your employer spells out the circumstances that will qualify and the employer has the final word regarding approval for the withdrawal. Examples of hardship situations include: payment of medical expenses for you, your spouse and your dependents; funds to avoid eviction from your primary residence; funds for post-secondary education expenses for you, your spouse or dependents; and funds to assist you in purchasing a primary residence.
The disadvantages of hardship withdrawals include:
- You’ll owe income taxes on the proceeds.
- If you are under age 59 1/2, you may face a 10% federal penalty.
- The withdrawn funds cannot be placed back into your account, so you have lost the tax deferral benefits forever.
- You will not be permitted to contribute to your plan for a 6-month period.
There are countless reasons to want to borrow from your 401(k) plan and you may have a legitimate hardship, but borrowing or withdrawing from a 401(k) plan is not advisable. In addition to the aforementioned tax considerations, it is symptomatic of poor financial health. If you find yourself in this situation, you should seek the assistance of a reputable financial advisor.
You can find a Certified Financial Planner™ professional near you by visiting www.CFP.net.