GOLDEN VALLEY, Minn. - One in four Americans has tapped their retirement savings via a 401(k) loan, according to a study by HelloWallet.
While the access to your nest egg may be appealing, you should know the risks as well as the benefits before borrowing your hard earned dollars.
Dan AmentFinancial Advisor with Morgan Stanley in Wayzata spoke on KARE 11 Sunrise about what you need to know about borrowing from your 401(k) is
Check with your plan administrator: The ability to borrow from your 401(k) is specific to your company retirement plan. Before assuming you can do so, confirm with your plan administer your ability to do so. Many retirement plan platforms offer loan modeling tools for you to forecast the available loan amount, predicted interest cost and expected repayment plan.
Why 401(k) loans are popular: Interest rates can be attractive, and as both bank and borrower, the employee gets to keep the interest. But lately borrowing from a 401(k) plan has taken on new appeal; since credit-card companies have cut cardholder limits and home-equity .... Well it doesn't exist any longer for many. Meanwhile, there are few restrictions on who can borrow from a 401(k). The loan typically can't exceed half the balance, or $50,000, whichever is less, and there are not significant fees involved in doing so. What is more, with interest rates so low and the stock market volatile, a 401(k) loan can be an appealing source of funds for some 401(k) savers. As an example, a borrower who uses the money to pay off high-interest debt, the effective return can be significant; thanks to the savings they get by replacing it with the lower-interest loan.
Risks you need to know: There are enough strings attached to these loans that financial advisers have typically cautioned people to consider the risks before committing. The loan can stand only as long as you are employed by the company. Lose your job, and the full balance is due, within 60 days typically, or it is counted as an "early withdrawal," and the borrower will have to pay income tax and a 10% penalty on the balance if he or she is younger than 59½. If you are taking out a loan to pay off credit card debt, make the commitment and plan to avoid adding back to those credit card balances or you'll end up in a worse predicament down the road. If you are facing the risk of bankruptcy, remember that your 401(k) may offer additional creditor protection. If you take a loan against your plan, these funds are no longer under the umbrella of protection in the case of bankruptcy. Loss of investment growth; if you are optimistic about the prospects for your investment holdings, be mindful that the loan amount you have withdrawn will not be enjoying this potential growth ... conversely, if the market declines during the term of your loan, you have avoided the negative impact on the amount of your outstanding loan. Negative tax impact; when you pay back your loan, you are doing so with after-tax dollars. As a result, a $100 loan payment reduces your tax home bay by $100. BUT, when you take the money out of your 401(k) plan in retirement, you will pay tax on the same money again.
It isn't not all bad news: While much focus is placed on the economic difficulties many families are facing, there appears to be evidence that Americans are working to get debts in better alignment with their incomes. Prior to the crisis of 2008, Americans have debt payments as a percent of disposable personal income was running over 14%. As of the 4th quarter of 2012, this ratio was estimated to be at approximately 10.4%, the lowest level in more than 25 years. Source: J.P. Morgan Asset Management
Weigh your options: Understand the pros AND cons before taking a loan from your 401(k). Depending on the timeline you intend to repay the debt, other sources of cash may be for appropriate if available.