borrowing from 401K

19 years ago

I have need to pay for some repairs on auto and house I cannot afford to wait- I just do not have $$$ in budget right now. I have a decent amount in my 401K and was going to borrow about $2500.00 from it - I know there is some penalty in doing this- What are the pros and cons.... isn't it already my money and can I not repay via a paycheck deduction??? Can someone explain in plain terms since I get confused easily when talking about money. My employer allows us to borrow against our 401K

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Comments (12)

aphilla
19 years ago
Suze Orman posted a column recently about emergency funds on yahoo. There's some good text in it that might help you think about this decision:

http://finance.yahoo.com/columnist/article/moneymatters/7599
weed30 St. Louis
19 years ago
How fast can you pay it back?

Here's another article:

Here is a link that might be useful: borrowing from 401K
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"I would avoid a loan from my 401K at all costs. You pay it back with post-tax dollars so you are taxed on it twice and if you ever leave your company, or worse, get laid off, the balance is due in 60 days or so. I've seen the "taxed twice" claim about 401K loan many times, usually on the websites of big investment companies who have a stake in keeping your 401K accounts to themselves for as long as possible. It's bogus. Anyone who takes out a 401K loan will make monthly payments back into the same 401K, usually for a period of five years. Of course the payments are made with after tax dollars, but the same would be true of paying back any loan except for those tied to a mortgage, such as a HELOC. And once it's paid back, the withdrawals you take out when you finally retire will be taxed at the same rate as they would have been if you had never taken out the loan. You pay interest on the loan at a fixed rate that is set by the plan and usually lower than any rate you could get for an unsecured loan. That means the unpaid loan balance is earning returns at that fixed rate. If you happen to take out the loan at the beginning of a down market, it'll likely be earning at a better rate than the rest of your 401K, and you will actually have a larger 401K balance at the end of the loan than you would have had otherwise. In times of an up market, however, the reverse will be true. The real and best reason not to do it is if you think you might leave your employment, voluntarily or otherwise, before the end of the loan term, because you will have to pay it all back.
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borrowing from 401k
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good grief. On an FHA 203b loan, you now have to have 3.5% of your own money; you can get a gift for the closing, or you can ask your sellers to pay closing, but you have to have 3.5% of your own money. All you're doing with your 401k is "borrowing" from yourself; it is your money. Your employer doesn't have a say in it, but you'll have to go through a process to get the funds out, as 401k money can be withdrawn only for certain uses; buying a home is one of the allowable uses. You need to check with the program administrators to find out an estimated time line; don't know how it is now, but several years ago, I had a sale that was put back for several weeks because the committee only met once a month. You might also check on using the tax credit for the down payment; I haven't had to do one like this, but my loan officer tells me it can be done. You'll need to amend your 2008 tax return, which your tax preparer will know how to do, & consult with your loan officer. Best luck, & don't get discouraged by the lectures people sometimes feel obligated or entitled to deliver.
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It's good because you are "borrowing" your own money. I think the interest rate was about 5 or 6 % compared to 15 to 22 % on credit cards. I owed $15 thousand on credit cards, shame on me. I borrowed against my 401k but was very strict about paying it back. I paid it all back within two years. So for me it was "good". It is nice to see my account is back "whole" again. I don't plan to borrow against it ever again. I learned my lesson!
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clemrick
19 years ago
Well, the money you borrow isn't going to be earning the same as the rest of your money. Even though the interest is paid to your account, it won't be as much as the regular earnings, provided you have a good 401K account.

Secondly, if your employment terminates, for any reason, you have to immediately pay back the loan. Can you do that if you are no longer employed?

Have you checked with your bank or mortgage holder to see if they have a no-cost HELOC you can open?
clg7067
19 years ago
You can borrow up to 50% of your vested 401k account up to $50,000.

I believe the major drawback of borrowing from your 401k is that you miss out on the compounding of interest. There's no actual penalty other than that provided you pay it all back. You pay yourself back with automatic monthly payments over 5 years with interest (the interest is to yourself as well). Now, I believe that if you're not earning much in that 401k, its not so bad.

If the choice is between borrowing from your 401k or a credit card with 20% interest, then I'd go the 401k. But, ideally you should start saving an emergency fund for these kind of things.

I didn't check the link to Suze's page, but I know she's dead set against this. I think sometimes she's a bit harsh. JMO.

Here is a link that might be useful: Smart Money
Meghane
19 years ago
You have to pay income tax on the money you withdraw, so add whatever your income tax rate is to that $2500. For me, it would be higher than my credit cards. And if you're close to the next tax bracket, that could send you over the edge.

Money invested into your 401k is pre-tax. But the loan you repay into the 401k comes out of your paycheck AFTER taxes, so you also pay income tax on the amount you repay. You basically get double taxed. There is an exception for education expenses but you have to prove that the money went for education.
josestrauss
19 years ago
You don't need to pay taxes if you are borrowing the money.

For a short term emergency, it's a reasonable option. My advice is do it this one time and then start a top priority savings plan to make sure that you accumulate at least 6 months worth of expenses in a relatively liquid form. You should try very hard not to get yourself into a situation where you can't take a $2,500 surprise without borrowing.
chelone
19 years ago
Rather than taking money OUT of your 401K, I wondered about using it as collateral for a loan; you aren't using the funds directly, you are simply leverageing a portion of them to secure a loan... failure to repay what you've borrowed would incur drastic penalties, but dire circumstances extract dire promises... how we "own up" to those promises defines our character. Maybe I'm missing something really important here?
kats_meow
19 years ago
Well, I doubt you could pledege an exempt asset as collateral...

Maghane ... you do not have to pay taxes on money that you borrow from a 401k unless you elect not to repay the loan.

I understand the reasoning not to borrow from a 401k but think in some situations it makes more sense than borrowing money at a high rate of interest.
jlhug
19 years ago
If a loan from a 401K is repaid within 5 years, there are no tax implicaitons. If it is not repaid, then it is considered an early distribution and is taxed as ordinary income and a 10% penalty is added. Now, it is not always easy to get a loan from a 401K. That depends on your plan.
chelone
19 years ago
I don't understand "exempt asset". (I don't have a 401K so I don't know how they work). Could someone please explain this to me?
josestrauss
19 years ago
In the context that it was written, I imagine that it means that it is something that the bank can't take from you even if you default on the loan. If that's the case, then it can't meaningfully be pledged as collateral for a loan.

In normal circumstances, no one can force you to give up certain assets even if they get a judgment against you. Retirement savings, life insurance policies, some home equity, and the tools of your trade are some things that are typically covered. There are exceptions. The bank can take your house if you don't pay your mortgage.
chelone
19 years ago
Thanks for the clarification, Jose.. I didn't know so many things were "off limits" in the event of a default! It never crossed my mind that an asset you "own" couldn't be put up as collateral in part or in total.

Something sticks in my mind that you can borrow against a life insurance policy... I seem to recall my father telling me that he did that, but that was a long time ago and perhaps the rules have changed in the years hence. I'll have to check into what the options are for the policies we have.

So much to learn!

borrowing from 401K

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aphilla

weed30 St. Louis

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