Borrowing From Your 401k

You might’ve seen the recent study released by HelloWallet that said about 1/4 of American borrowed from their 401k plan in 2010 for non-retirement expenses such as mortgage payments, credit card bills and school expenses.  That amounted in $70 billion in early withdrawals.  While it’s strongly advised to never borrow from your 401k or other retirement accounts, there are some instances where you might get away with it.

First off, you should amass an emergency fund that you can tap into for unplanned events.  You should never go into your 401k for stuff like vacations or a fancy new car.  The more money you have in your plan and the longer it’s in there, the more it will grow and thus the more you will lose if you take it out.  But what if you don’t have any other options?

You may want to take a loan out from your 401k.  If your plans offers the loan option, you may borrow up to half your salary up to a max of $50,000.  The big concern here is that if you lose your job, then you have to pay the loan back quickly (usually within 60 days).  If you default, it’s treated like an early withdrawal and taxes are due in addition to a 10% penalty.  The advantage though is that you pay back the interest to yourself often at prime plus 1%.  It makes sense if you use the loan towards an investment or to eliminate high cost debt.

You might want to borrow if you suffer a hardship.  Primarily these reasons are foreclosure avoidance or to pay medical bills, a funeral or college expenses.  You may also use this to purchase your primary home.  Since 401k funds are protected from bankruptcy, you may want to elect that or foreclosure.  Talk to a financial adviser to see what’s right for you.

Finally, the biggest leak in 401k plans is cashing out when you leave your job.  This is not recommended but may prove worthwhile if you are young and are looking to further yourself in the present.

As I’ve stated before and will do it again, it’s never smart to borrow from your retirement nest egg.  But sometimes, life gets in the way and your hand is forced.  If you need help managing your retirement plans, contact the tax experts at the IRA Financial Group today.

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