The 401(k) Loan - Is It for You?

A retirement plan or 401(k) is a viable way to save for your retirement as it offers more advantages compared to Social Security pensions. One of the major advantages of a 401(k) plan is its tax perks. Your contributions are not taxable until after you start getting your benefits. Also, the contributor gets to decide how much to invest unlike with Social Security where a set amount of contributions are taken out of your wages. There are a number of other reasons why more and more people are investing in their 401(k). But did you know that you may also take out a loan on your account? If you are in need of extra funding and have run out of choices, you may want to look into 401(k) loans. It is recommended, however, to be aware of the issues surrounding retirement plan loans so you know for sure if this is indeed the right loan for you. The Good It is fairly easy to take out a loan from your retirement plan. You won't usually be burdened with the inconveniences associated with most other loans, such as long application processes and stringent qualification requirements. There are also practically no restrictions as to how to use the money. You can use the money to buy a car or refinance a house. Interest rates imposed on retirement plan loans are also very attractive and the interest rate that you pay is credited to your 401(k) account so you are essentially paying yourself back. No taxes are imposed on the interest until you have retired. The Bad While the interest on the retirement plan loan is tax-sheltered, it is not tax deductible. The opportunity costs that come along with 401(k) loans are also a major drawback. This means that benefits such as tax-deferred compounding are not applicable to the money that you borrow. Your contributions to your 401(k) plan may lessen when you take out a loan. Because you have monthly payments to worry about, you may compensate for this by reducing the amount that you invest in your retirement plan. Most companies also charge a fee for retirement plan loans plus payment terms are not flexible. You have no way of changing the terms that go along with accessing the loan. If you are delinquent on your payments this could impact heavily on your financial future. If you are to move to another company, you will be required to pay for the whole amount, usually within 60 days from the time you quit. If you are unable to repay the loan, taxes will be imposed on your payable balance, plus there are certain penalty fees that you will have to pay. The Bottom Line Your retirement plan could be a good source of much-needed cash, especially if you are taking out a loan for compelling reasons. But remember that the reason you invested in a retirement plan in the first place is so that you can realize your long-term dreams. If you can acquire the money you need from other sources, then it is much better to leave your retirement plan untouched.