If you have a good amount of cash stashed in an employer-sponsored retirement savings plan, you may be eyeing those funds to use for something other than your future. However, before withdrawing a penny from your 401(k) or 403(b) plan, know the facts about this type of loan. Just because you can doesn’t mean you should.
- You have access to potentially large quantities of cash (most plans offer loans against contributions of up to half of your vested balance, with a $50,000 limit).
- The interest rates are usually low – typically the prime-lending rate plus one or two percentage points.
- There are no restrictions for how you spend the money.
- They are convenient and easy to obtain – requiring only a phone call, or filling out a short form.
- There is no credit requirement.
- The typical repayment term of five years fits most borrowers’ needs.
- The interest you pay is tax-deductible if the money is used to buy a primary residence.
- Under most plans, if you leave your job (whether you’re laid off, fired, or if you quit), the remaining balance of the loan will be due immediately.
- Can’t repay the loan? You’ll be taxed on the earnings, and if you are younger than age 59 ½, you will also be penalized 10% for an early withdrawal.
- Obtaining a plan loan can be too easy. Spending issues may remain unresolved while your retirement savings is jeopardized.
- You will lose all future compounding interest on the lost earnings for the amount you have borrowed.
- You could be subject to double taxation. The interest you pay yourself on the loan comes from money that has already been taxed. But the assets in your plan count as untaxed earnings. That means you will pay taxes on that money again in retirement when you make withdrawals from the plan.
- There may be fees for obtaining the plan loan – a one-time fee, maintenance fee, or a combination of the two.