401k retirement plans are meant to grow tax-deferred continuously (without any withdrawals) up until you hit retirement age. However, we don’t live in a financially perfect world. Things may come up in your life that require you to have immediate emergency funds for example death of spouse, big medical bill, etc. In such an event, yes you can withdraw money from your 401k retirement account.
Here are some characteristics of borrowing a 401k Loan:
– You can borrow 50% of your entire retirement savings account for upto $50,000.
– Repayments must be made in 60 equal monthly payments over a 5 year period. However, if you borrow this money for a mortgage purpose (your prime place of living), the repayment period is then higher.
– There interest rate you will pay on the loan is the Prime Market Rate + 1%. Check bankrate.com for the current prime rates.
– Repayment of loans will occur automatically from your payroll cheques. You therefore have no control over paying back the money, it is automatically deducted from your checks.
– You can repay back the entire amount of the loan without any penalties.
– You can take out multiple loans and the minimum loan you must take out is atleast $1000.
Advantages & Disadvantages of 401k Loans
Advantages of 401k Loan
Disadvantages of 401k Loan
|1) No Paperwork: Most plans allow you to fill out an online form for a loan application. Others require you to call 1-800 number. Whatever you choose to do, atleast there is no lengthy paperwork!
2) You can borrow for any reason you wish. However, since you are playing with your retirement money, it better be for a good reason.
3) You will receive your loan amount within a matter of a few days.
4) You get charged the Prime Rate which is what banks charge their best credit standing customers. You will pay Prime Rate + 1%.
5) The prime rate you will be repaying might actually be higher than the original interest rates you were receiving from your 401k retirement account. For example, if the prime rate is 7% and you were only receiving 5% from a money market instrument, you are actually getting a better rate of 2% higher!
|– If you default on your loan repayments, you will have to pay a 10% penalty fee (if you’re 59.5 years or less) plus federal and provincial state income taxes.
– Most plans will charge you a fee for taking out a loan. The fee ranges from $5 – $100.
– If you take out money from a 401k retirement account, you will lose all the compounding interest that you could have earned, therefore diminishing your future earnings.
– Some 401k accounts require your spouse’s approval for any loan amount.
– The prime rate you will be repaying might also be LOWER than the original interest rates you were receiving from your 401k retirement account. For example, if the prime rate is 7% and you were receiving 9% from a money market instrument, you will be losing a 2% interest rate thus diminishing your future earnings.
Note: Do not default on your loan repayments! Incase your lose your job (for any case whether your employer goes bankrupt or you’re laid off), the loan automatically becomes due. You will be given a certain amount of time to pay it back. If you fail to do, you will be classified as “default.” If you are on default for a 401k loan, you will be charged a 10% penalty fee for the outstanding loan amount as well as pay federal and local state taxes.