401k Loan

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Regardless of the whichever company a 401(k) is handled by or the specific definitions of the plan, all 401(k) plans are designed to staunchly deter any early withdrawals from the account. However, some 401(k)s plans may allow individuals to take loans out against their account. All 401(k) plans generally have rules established which govern whether or not such loans are permissible, and under which circumstances these loans may be made.

Disadvantages of borrowing against a 401(k):
Generally, borrowing against a 401(k) plan should only be taken into consideration as a last resort measure after all other possibilities for obtaining funds are exhausted. There are some serious disadvantages associated with this type of loan.

Whatever money is loaned out from the account is not earning any interest for the duration of its absence. Paying off the loan may prevent the planholder from contributing any further funds into the account while he or she must repay the debt. This further reduces the amount of money in the account that otherwise might be earning compound interest and greatly reduces the overall end value of the 401(k) at retirement. In addition, the money used to repay this loan is after-tax income, which negates the most of the benefits of tax deferment.

Also, the money borrowed from the 401(k) account is subject to being taxed twice, once as income tax when the money is paid out to the borrower, and again when the money is withdrawn when the plan matures at retirement.

Limitations on 401(k) loans:
If circumstances allow for a loans to be made, the value of the loan is usually limited to around $50,000 or about half the total value of the 401(k) account, whichever is less. The company may also elect to impose a minimum on the amount borrowed from the account.

On the plus side, 401(k) loans are usually very easy to obtain, since the planholder is borrowing from themselves. No credit check is necessary, and the interest repaid on the principal also goes into the account. This interest is likewise tax deferred until withdrawal.

Repaying a 401(k) loan:
Loan repayments are normally taken directly from the employee's paycheck to deposit back into the account. The repayment period of a 401(k) loan is limited to about five years, with some exceptions. The duration may be extended for a loan in which the money was borrowed by a first time homebuyer in need of funds with which to purchase a residence.

Expediting the repayment of a loan and continuing normal contributions, if possible, are vital strategies in minimizing the loss of the value of the investment into a 401(k) plan.

Other considerations:
If employment is terminated for any reason, the remaining balance of the loan may come due in full immediately upon departure. If the planholder is unable to come up with the balance of the loan by the required deadline, the loan automatically defaults. To make matters worse, the remainder of the account then becomes taxable as if it were an early distribution, plus the remaining amount will be subject to the 10% early withdrawal fee.

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