When Should You Borrow from your 401k?
The short answer: never, if you can help it. Unfortunately, there may be a time when you feel as though you have no other recourse but to tap into your retirement fund. Unforeseen circumstances like the death of a spouse or family member, large medical bills, and similar situations can leave you, and your bank account, feeling drained. In these situations, it might be possible to borrow from your 401k without incurring penalties, but before you decide, keep in mind the following
When You Borrow from your 401k
- Repayment of the loan will be taken directly out of your paycheck-just as if it were a wage garnishment, meaning that you will have no control over your own repayment.
- You can borrow up to 50% of your total 401k retirement savings, not exceeding $50,000.
- The interest rate on your 401k loan will be the Prime Market Rate plus an additional 1%.
- Repayments annuitize, unless you are taking out a 401k loan for mortgage-related reasons. In this case, the repayment period will most likely be longer.
- The minimum loan amount is $1,000.
- You are allowed to take out multiple loans
- There is very little paper work required to apply for a 401k loan
- There are no limitations on reasons for borrowing, but keep in mind that only certain reasons may qualify for the penalty-free borrowing option
- The prime rate on your loan will most likely be higher than the interest that you received on your 401k account.
- Default requires a 10% penalty fee, unless you are aged sixty and older, plus federal and state income taxes.
- If you lose your job for any reason, your 401k payment is automatically due. Failure to pay in full after the specified date will result in a defaulted loan status. This means that you will be charged a 10% penalty fee, and required to pay state and federal income taxes.
- There is usually a fee that you will be required to pay before you can accept your loan. These fees normally range from $10-$100, but make sure to read the fine print carefully before signing.
Your 401k: Your Future
Your 401k is designed to be your retirement savings account and provide you with added financial security in your golden years. For that reason, most financial planners, tax advisors, and others will advise you against borrowing from your 401k unless circumstances become absolutely dire. Be sure that you are well informed about all of the risks and benefits of such an action before you sign on the dotted line.