Caution Flag: Loans from your 401k Plan

| June 16, 2015

Many people out there have a 401k plan at work. These plans have lots of good features like a company match, and investment choices. Some, but not all plans, may allow you to take a loan against your 401k balance. In today’s blog we are going to take a dive into the pros and cons of borrowing from the money that is supposed to be used for your retirement!

If your plan allows you to take out loans from your 401k, this can be mighty tempting. This is because it’s an easy source to tap on short notice; there’s no long application process or credit check. We’ve even heard of plans offering 401k loan debit cards!

Alright, here comes the lecture: Remember that your 401k is intended to fund your retirement, not to be a source to borrow against. It’s a savings vehicle, not a borrowing vehicle - that defeats the whole purpose! Taking money out too early can cause you to run out of money in retirement.
Simple Question: is there a retirement crisis here in America? Hmmm?

5 STAR TIP:DON’T BORROW FROM YOUR 401K PLAN! You’ll thank me later…

Aside from the guilt trip, how would a loan work?

Ok, if your electricity is about to be cut off, and there are no groceries on the table, borrowing from your 401k plan may be an option. But there are strings attached, so you must be careful. There are rules that you must follow to keep the loan from being deemed a distribution, thus setting off a tax time bomb causing taxes, and possibly penalties! Remember the devil’s always in the details. So when it comes to the plan basics, there are three main conditions that must be met so the loan stays a plan asset - and not transformed into a taxable distribution:

  1. Loans must be repaid within five years (except for a principal residence, which can go longer). 
  2. Payments must be made at least quarterly and be equal for the term – for example, you can’t make payments of $100.00 a month and the last month make a large payment to pay off the balance. They have to be equal across the board. 
  3. There are loan limits that cannot be exceeded. It must be the lesser of:
    • $50,000 
    • Or $10,000, if you don’t have a balance of $10,000 then it’s half the vested loan balance.

Keep in mind your employer is not obligated to offer you loans, it’s optional. In the case of small businesses, many cannot afford to have this kind of service.

What happens if someone leaves their job with a loan?

If you leave your job, generally loans are to be repaid within 60 days or it will be a deemed a distribution and subject to tax and maybe penalties.

Generally if you think you will be leaving your employer soon, you should not take out a loan. To find out if your plan has loan provisions, check your summary plan description or check with your plan administrator.

Here at Piershale Financial Group, we specialize in helping the innocent and unwary avoid stepping on penalties and hurting themselves. We very much believe in the theory that it’s much better to avoid a problem than it is to solve one. If your advisor does not subscribe to that theory then come visit us.

If you would like more information on the pro and cons of this or other topics we discuss, just contact our office for more information. As always, thank you for reading!

The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.