Should You Take Out Loans On Your 401(k)?
If your employer offers a 401(k) plan, then you've goat a pretty good "perk" at work. In fact, a 401(k) is one of the best retirement savings vehicles available. Your contributions are made with pre-tax dollars, which means you can lower your taxable income. And your 401(k) earnings gro tax-deferred, so you pay no taxes until withdrawal, usually at retirement. Consequently, your money has the potential to accumulate much faster than if it were placed in an investment on which you paid taxes every year.
Many people take advantage of another feature offered by a 401(k): loans. Your 401(k) plan may allow you to borrow money from your account. Typically, you can borrow up to half of your vested account balance, or up to a maximum of $50,000. The questions really isn't whether you can borrow money from your 401(k)--it's whether you should. As with most financial decisions, there are "pros" and "cons" to consider.
On the "pros" side:
- You'll have ready access to needed cash. Most 401(k) plans permit you to borrow money for any reason--and you may be able to get your money within a week.
- You pay interest back to yourself. You'll have to pay your account back through after-tax payroll deductions. The interest rate charged on your 401(k) loan may be slightly lower than that of a bank loan, but the 401(k) Loan rate would still have to be competitive. However, the exact rate depends on your individual plan.
On the "cons" side:
- You may be missing out on investment growth. Your account might be able to earn more if you left the money invested, despite the fact that you're paying interest to yourself on loans. Over the past several years for example, the Standard & Poor's 500 has averaged more tha a 15 percent annual return. But if you had borrowed from your 401(k) and you were repaying yourself, you may have earned interest of only 8 precent or 9 percent.
- You may have to pay off a lump sum if you leave your job. Most plans require you to repay your loan within five years. If you leave your job, you will probably have to repay the outstanding balance within 30 to 90 days. If you can't make the payment, your loan will be considered in default and the balance will be considered as a taxable withdrawal. If you are under age 59-1/2, you also may have to pay a penalty for early withdrawal. (However. if you are 55 or older when you leave your job, you may be able to avoid this penalty.)
You'll have to weight these and other issues before you decide whether to take out a 401(k) loan. Keep in mind, however, that your 401(k) is a retirement plan. The government provided 401(k)s with special tax advantages, with the specific purpose of helping people save for retirement. So think long and hard before using your 401(k) for some other purpose, no matter how tempting.
- Agencies on Aging around the country direct older Americans to government offices and other community resources that can help with financial problems and questions. To find your nearest Agency on Aging, call the Eldercare Locator (800-677-1116), a service of the federal Administration on Aging. The Administration on Aging also has a useful Internet site with links to the Eldercare Locator plus other on-line sources of financial information.
- The Consumer Information Center is a clearinghouse for free and low-cost booklets published by various federal agencies. For a free catalog, write to Consumer Information Center, Pueblo, CO 81009, or call toll-free 888-878-3256. Or, if you have access to the Internet, you can get the full text of the publications free.
- The FDIC and other federal banking agencies publish information about retirement savings and can respond to questions and complaints about discriminatory lending practices or other consumer matters.
- The Internal Revenue Service can assist with tax-related questions, such as when you can withdraw from a retirement account without a penalty. The toll-free phone number for IRS publications is 800-829-3676. Recorded information about commonly asked tax topics is available at 800-829-4477. Help also is available at the IRS Internet site. If you still have questions, you may call your local IRS assistance number listed in your telephone directory or try the central office at 800-829-1040.
- The Pension and Welfare Benefits Administration, part of the U.S. Dept. of Labor, protects consumers by enforcing federal laws governing pensions and other employee benefits. For inquiries, contact a nearby office (in the federal government listings in your phone book), call the Washington headquarters (202-219-8776), or write to the PWBA, Office of Program Services, Department of Labor, Washington, DC 20210. For publications only, call the PWBA toll-free (800-998-7542) or visit its Internet site. protects consumers by enforcing federal laws governing pensions and other employee benefits. For inquiries, contact a nearby office (in the federal government listings in your phone book), call the Washington headquarters (202-219-8776), or write to the PWBA, Office of Program Services, Department of Labor, Washington, DC 20210. For publications only, call the PWBA toll-free (800-998-7542) or visit its Internet site.
- The Social Security Administration can provide information about your Social Security benefits or about how to file a benefit claim. Call or visit a nearby SSA office (listed in the phone book) or call the agency toll-free 800-772-1213. The SSA also has an Internet site with lots of information, including answers to commonly asked questions. If you need more help by mail, write to the SSA, Office of Public Inquiries, 6401 Security Blvd., Baltimore, MD 21235.
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