401(k) Plan Loans: Not the No-Brainer You Hoped For
In a past column, I covered how to make the most of your 401(k) when changing jobs. As a CPA, I hate to see anyone pay unnecessary taxes and penalties, so I gave that subject top priority. Today, I’ll take on another practice that is best approached with extreme caution: borrowing money from your retirement plan account.
Some (not all) company retirement plans let you borrow money from yourself, letting you tap your retirement plan assets for immediate spending needs. Typically, the maximum amount you can borrow is the lessor of $50,000 or one half of your vested account balance. Here are a few caveats to be aware of:
Double Tax – You’ll be required to pay yourself interest – typically prime rate + 1 percent. That’s good for your retirement, since you have paid back more than you borrowed after you settle the loan. But it’s not such a tax-wise idea. The interest is paid with money that has already been taxed. It’s taxed again when you withdraw it in retirement. Both times, it’s taxed at typically higher, regular income tax rates.
Opportunity costs – While your money is out on loan, it’s not earning market rates of return. Missed market appreciation could cost you multiple times more than the cost of other loans, such as a home equity loan.
Employment status – If you leave before you’ve repaid the loan, expect the loan to come due immediately (whether you’ve left voluntarily or not). Any unpaid balance becomes income subject to ordinary Federal and state income taxes, plus a 10 percent penalty if you’re under age 59 ½.
I’m not saying you should never borrow from your retirement plan account. If you face a medical emergency or similar hardship, it still may be your best available option. But do consider a 401(k) loan your choice of last resort. Your future self will thank you.
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