Borrowing against your 401(k)

October 07, 2014

By Jess Bedsole

Borrowing against your 401(k)

Hopefully, you have a 401(k) in place already where you and your employer contribute the maximum allowed amount per pay period. If so, that’s great! You’re on the right path to having a retirement nest egg when your working days are over.

However, sometimes if you are maximizing your retirement contributions, the cash flow you have left over is more limited than you’d like. Maybe you’re hoping to put a down payment on a house or perhaps medical or credit card bills have piled high or your home needs some renovations this year.

Here are some things to know about if you are thinking of borrowing against your 401(k) plan:

  • If the money isn’t in your 401(k), it isn’t invested and isn’t growing. Try this loan calculator from Bankrate to show what the difference in earnings will be if money is borrowed against your 401(k) plan. Some say every $10,000 borrowed can result in $100,000 lacking when it comes time to retire.  
  • The funds you borrow from your 401(k) are not tax deductible. Unlike your pretax 401(k) contributions, the money you use to repay your 401(k) loan comes from your already-taxed take-home pay. If you are using the money to buy or remodel a home, you should investigate the potential tax benefits of a mortgage and home equity loans, as the interest on those loans may be tax deductible.1 
  • You must be disciplined in paying back the money you’ve borrowed from your 401(k) plan. Some credit cards or personal loans have payback periods up to 30 years. Many 401(k) loans must be paid back in full in 5 years or less. If you leave your job you will have to pay back the 401(k) loan quickly or pay interest and penalties  
  • It’s not free money to borrow; 401(k) loans have origination fees and annual maintenance fees. Your company’s HR department will have more information on the total fees charged to borrow from your 401(k).

Now that you know it can be quite costly to borrow against your 401(k) plan, you probably want to know some alternatives to having a little extra cash flow.

If you are already a homeowner, consider a HELOC for additional funds. You can install a new kitchen, repair an outdated patio or put in a pool.

Trying to buy your first home? Think about where you can cut costs first to build your emergency fund and checking account. Consider canceling cable, simplifying your cellular plan or taking the weekly dinner and a movie off of your social calendar.

There are many ways to boost your savings today and prevent borrowing from your 401(k). Do the research to decide if taking a 401(k) loan is right for you, since it will definitely affect you in the long-run, when it’s time to retire.

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