GOLDEN VALLEY, Minn. - If you're ever in need of a big influx of cash, it could be tempting to tap into your retirement savings; recent numbers from the Employee Benefits Research Institute (EBRI) show 20-percent of American retirement plan participants have loans on their 401(k).
However, borrowing from your nest egg can bring possible pitfalls. Morgan Stanley financial advisor Dan Ament stopped by KARE 11 Sunrise to explain the options and potential problems.
Before dipping into your 401(k), Ament suggests first considering whether other resources are available. If you do want to borrow from your retirement, keep in mind the IRS limits loans to a total of $50,000 or half of the participant's vested balance, whichever is less. Also, you'll want to be aware that 401(k) loans incur an interest rate based on the Prime Rate plus 1-2% or about 5.25-6.25% today. Generally, repayments must occur within five years and interest is paid pack to the participant account. There may also be fees related to establishing your loan comparing available rates on other types of loans, such as a home equity line of credit.
However, the possible pitfalls are plentiful. Ament said 401(k) loans can potentially reduce investment returns by taking money away from your portfolio until repaid, missing out on potential growth. Also, depending on your plan, you may not be allowed to contribute to your 401k while you are repaying your loan. If so, you may be missing out on your company match.
Ament said an additional issue involves loans that are repaid with after-tax dollars, then taxed again when withdrawn at retirement.
Finally, Ament said to make sure your job is secure before tapping your nest egg. Employees who leave their jobs, are laid off or fired are typically required to repay their loan within 60 days. If they don't, the loan amount is considered a distribution, subjected to income tax and a 10% penalty if the borrower is under 59 ½ years old.
Ament said the bottom line is that you should thoughtfully consider all available resources and the true need before incurring penalties and taxes on a distribution from your retirement account. The long-term consequences may be greater than you think.