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This depends on your
particular situation and 401(k) plan. As a general rule, it is advisable to investigate
other loan sources (bank, mortgage company, tuition loans from schools or government)
before dipping into your 401(k).
Different 401(k) plans have different rules. Some do not allow loans, while others may
only allow them in certain cases. You should check with your HR or benefits department to
find out whether your plan allows loans, and under what circumstances.
If loans are permitted, they are generally limited to $50,000 or half of the value of your
account (your contributions and vested employer match contributions) whichever is smaller.
There might also be a minimum amount imposed by your company. Repayments of loan principal
and interest are deducted directly from your paycheck after taxes and deposited in your
401(k) account. You generally have to pay the loan back within five years, unless it is
used for the purchase of a primary residence, in which case you may have longer.
While it may seem like a good idea to borrow from yourself, there are actually some big
disadvantages.
The money you withdraw no longer earns compound interest, so your overall account will be
much smaller when you retire, especially if you also stop making contributions while you
are paying off your loan.
You will be taxed twice on the money you use to pay back the loan: once when you get your
paycheck, and again when you eventually withdraw money from your 401(k) account after
retirement.
If you quit your job, or are fired, you will probably have to pay back the full amount of
the loan right away (and just when you probably need the most). If you don't - if you
default on the loan - it will be treated as an early distribution from your plan and you
will have a hefty bill on your next tax return - federal, state and local taxes on the
entire amount, plus most likely a 10% penalty if you are under 59 ý.
When your loan payments are deposited directly into the account they don't necessarily go
back into the funds they were taken out of, so you have to be sure to rebalance your
portfolio to keep your investment strategy on track.
If you have no choice but to take a loan on your 401(k), keep the following points in mind
to safeguard your nest egg:
ý Pay the loan back as soon as possible.
ý Try to keep making contributions to the account even while you are paying back the
loan.
ý Don't default on the loan. |
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