401(k) Loan

Posted by on Nov 17, 2007 in Alternatives

401(k) Loan

A 401(k) loan is a risky payday loan alternative.

Although 401(k) loans are cheaper than payday loans or credit card cash advances, the benefits are outweighed by substantial drawbacks and risks…

Most 401(k) plans allow you to borrow up to 50% of your vested account balance. Usually, you have a maximum of five years to repay the loan.

Some employers impose restrictions such as:

  • minimum loan balances (usually $1,000)
  • a limit on the number of outstanding loans (to reduce administrative costs)
  • married employees must get the consent of their spouse (since both are affected by the decision)

Benefits of a 401(k) loan include:

  • no lengthy application process (usually a short form to fill out)
  • no credit check (it’s your own money)
  • low interest rate (usually prime plus 1-2%)
  • interest is paid back into your account
  • you pay no tax on this interest until retirement

The drawbacks and risks include:

  • the money you take does not earn interest, dividends and/or capital gains
  • repayments are made with after-tax dollars
  • when you retire, you pay taxes on this money again
  • you can’t deduct the interest on your taxes (like you could with a home equity loan)
  • if you are fired, the 401(k) loan must be repaid in full (normally within 60 days)
  • if you fail to repay the loan, you pay substantial penalties (for premature distribution)

Whenever possible, it is better to avoid 401(k) loans and consider safer payday loan alternatives. Try to leave your 401(k) untouched until you retire.

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