How Do 401K Loans Work?
Is a 401k loan right for you? Outlining the pros and cons of 401k loans.
401k loans are an option for individuals experiencing financial hardship. In addition, 401k loans can be issued to help pay the down payment on a home.
What are 401k loans?
A 401k loan is not technically a loan. It is your money that you have been contributing to the 401k for your retirement. 401k loans simply allow you to access a certain portion of that money. The law will allow you to borrow 50% of your 401k balance or $50,000. You will have 5 years to pay the money back. Individuals who are borrowing the money for a down payment on a house will have 30 years to pay the money back.
What are the pros of 401k loans?
401k loans do not require a credit check. This means there will be no application process for the loan and the loan is guaranteed. These loans also have a low interest rate.
What are the cons of 401k loans?
Individuals who fail to repay the loan in time will be considered a 401k distribution. You would owe taxes on the income as well as be hit with the 10% withdrawal penalty for individuals under the age of 59 ½. Another problem with 401k loans is severing employment. If you leave your employer before the loan is paid back you will be given a certain time period to pay back the loan or be hit with taxes and penalties. This time period could be as little as 30-60 days depending on your 401k plan.
Should I borrow from my 401k?
Consider your current debt load before borrowing from your 401k. Will you be able to repay the money in the time allotted? Other options, such as home equity loans, may be a better choice for you. Individuals should always consider the loan option before simply withdrawing contributions. There is no penalty in 401k loans but there is a penalty on early distributions.
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