Know the consequences before borrowing from 401k

(NEWS CENTER) -- Some 401k accounts allow loans, letting owners borrow up to $50,000, or half of the balance in the plan (whichever is less). This might be appealing for those in a tight financial situation, but Certified Financial Planner Sarah Halpin said it should be a last resort. The primary purpose of a 401k is to help living expenses in retirement.

Halpin said that before dipping into a 401k, there are several consequences to keep in mind.

Losing or Leaving Your Job: For those who borrow from a 401k, they are obligated to pay back the entire outstanding balance if they lose or leave an employer. Halpin said the loan usually must be repaid within 60 days. Any amount not repaid is considered a retirement distribution and may be subject to state and federal income tax and possibly a 10 percent early withdrawal penalty.

Double Taxation and Loan Length:A 401k loan results in double taxation, said Halpin . A 401k loan is paid back with "after tax" dollars, unlike the pre-tax contributions that fund 401k accounts.

Decreased Retirement Savings: Depending on the 401k plan's rules, owners may or may not be able to make the normal pre-tax retirement contributions while repaying the loan. In addition, not being able to continue pre-tax contributions could have an impact on income taxes as well as the retirement balance.

Consider Alternatives: 401k plans sometimes allow for a qualified hardship withdrawal which allows for a distribution and avoids any potential 10 percent early withdrawal penalty. Halpin said to look for lending options outside of the 401k account, such as a home equity loan a credit line or personal loan.

Halpin said to read through the 401k rules to understand the potential disadvantages of a 401k loan before signing on the dotted line.


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