Loans from retirement accounts such as 401(k) and 403(b) can be useful if you have a financial emergency or if you need a large amount of money to complete home renovation work or pay college expenses. Although it’s your money, there are many things you should consider before taking advantage of this retirement account through a loan.
401(k) Loans Are Not Free Money
One of the most common mistakes people make is thinking that borrowing from a 401(k) account is the same as going to the bank and withdrawing some money from a savings account. This is not true at all. When you borrow money from your 401(k) account, you are taking out a loan. Just like an auto loan or a mortgage loan, this means you are promising to pay back the borrowed amount with interest.
Interest and Fees Will Accumulate
Another thing to consider before borrowing from your retirement fund is the various fees and interest rates that you will incur. Most plans charge a loan fee which can be an establishment fee of up to $75, regardless of the loan size. This means that even if you borrow $1,000 and incur a $75 fee, you are losing 7.5% right off the bat.
Double Taxation Rules Apply
If you recall, your retirement account contributions are made on a pre-tax basis. This means you receive a tax benefit when you contribute to the plan, and you will be taxed later when you withdraw the money from the plan. Unfortunately, when you take a loan from the plan, you may be subject to additional taxes.
Compound Interest Power is Reduced
Compound interest is one of the greatest assets you have in a retirement plan. Over time, the interest and gains on money in your account can accumulate significantly. The longer you allow your savings and investments to grow, the greater the opportunity for your money to grow.
Consequences If You Leave Your Employer
As mentioned at the beginning, this is a loan and it must be repaid. If you leave the employer that sponsors the plan, you are still obligated to repay the loan. In some cases, you can request a coupon booklet and continue making payments, but if you fail to maintain the payments or cannot repay the loan in full, you will be in default.
Final Thoughts
Of course, things happen in life, and there are times when you truly need some extra cash. In fact, it’s better to have an emergency fund set aside for those situations, but for many, turning to a retirement plan may be one of the few options available. Before moving to a 401(k) loan, make sure to review all other options available to you and ensure you fully understand the cost of borrowing from your retirement account.
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Source: https://www.thebalancemoney.com/should-you-take-a-401-k-loan-1289856
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