401k Loan

If you're thinking about taking a 401k loan there is a LOT to know! This article goes over what the rules are, how things work, and some penalties if things don't go as planned.

The first thing to know is that not every employer allows you to borrow from your retirement savings, so you'll want to check with your account holder to make sure this is even an option for you. If it is, you can borrow up to $50,000, or half of your account balance, whichever is less. The interest you pay on this will be very, very low when compared to traditional financing options, and the interest you pay will be paid back into your retirement account, so you're basically paying this interest to your future self. This is something most people appreciate as a huge upside to this financing plan.

Now, if you were to cash out from your account instead of taking a 401k loan you would pay a ten percent early withdrawal penalty, as well as federal and state taxes on the money you withdraw. This could easily total twenty to forty percent of the amount you withdraw, depending on the tax bracket you fall into. This doesn't account for the money you will also lose that you would have made in returns on your investments over the years between now and retirement, which is a big loss to your savings goals.

Taking a 401k loan is a great way to avoid doing this, but the biggest downside to this option is that you might end up cashing out anyhow. If you fail to repay the balance in five years, it will be treated as though you had cashed out in the first place and you will owe the ten percent early withdrawal penalty as well as taxes. Also, if you change jobs, or unexpectedly lose your job, the balance suddenly becomes due in full and if you don't repay it then it will treated as though you cashed out in the first place and the penalty and taxes will have to be paid on the money. This is a big, and scary, downside.

Because of these very harsh, and very possible, consequences it is generally advised that you avoid this option unless the only other way you've found is to cash out, then a 401k loan may be preferable to simply cashing out in the first place.