There are diverse controversies around 401k plan, such as what 401k rollover options are, why 401k transfer to IRA is a better choice, etc. As a worker, you and I are no strangers to “401k” but how well do you know what it is?
In laymen terms, it can be described as “a defined contribution plan provided by a company to its employees for their retirement purpose” with the benefit of deferred taxes on those contributions. It’s IRS rule that employee had better not request 401k savings distribution before reaching a specified age without triggering any tax penalty.
But in the economically challenging situation like now, some of us are possibly facing financial chaos that urges us to take an emergency loan. It could be for paying tuition fees, making a purchase, paying out mortgage and taxes or surviving and funding daily expenses because of the plummeting income. Then we think we’ve made all possible efforts to stay afloat but you feel like being a loser.
Under such a difficult circumstance, you may get tempted to take out 401k loan. But think again, is it the right way to tackle problems once and for all or will it potentially drag you to a worse situation?
401k Loan Rules
Typically, a 401k loan is minimum $1,000 and maximum the 50 percent of the account balance up to $50,000, while the repayment occurs evenly over a period of 60 months (5 years) or in the case of a home loan, up to 15 years.
That said, let’s review what a loan against 401k can do for and against you.
Pros of 401k Loan
- Ease of borrowing
It does not take a lengthy series of financial procedures to do this. Grab your phone and tell them (your plan administrators) what you want, that easy! It is your money so it makes sense why borrowing is a piece of cake. - No credit check
Unlike ordinary loan, you’re not subject to a credit check. It’s your money that you borrow. - Tax-shielded interest
It is not mandatory to pay taxes on the interest until your retreat. - A huge return
Because you are borrowing your own money, it is sensible to say that you keep the interest you pay on the loan. - A very competitive interest rate
Even for someone with poor credit score or stained credit history, getting this low interest rate is not an ordeal.
Cons of 401k Loan
- Greater concerns
While spending your own retirement funds, you are likely to go through some sleepless nights, wondering how your post retirement days will be if you cannot repay within a specified period. - No tax advantage
The loan tax is not reduced. - Loss of interest
By cashing out, you lose the interest. - Risk of being an untimely distribution
Suppose your plan to repay falls through, you’ll have to pay penalty tax and income taxes. - No tax shield
You must pay taxes twice, while repaying the loan and while you retire. - Decreasing capital
While focusing on paying out your 401k loan, you still have to contribute to the retirement saving. That means you may have to work harder as twice.
In any case, if you are going to borrow against your 401k account, it should really be used as last resort option. If there is really no other alternative option, then it makes sense to request a 401k loan, but while keeping in mind its pros and cons.
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2010 Contribution Limits
The 401(k) contribution limit for is $16,500 for those under 50 years old. For anyone between the ages of 50 and 59 ½ years old you also have the option of contributing an additional $5,500 as a catch-up contribution.The IRA contribution limit for is $5,000 for those under 50 years old, with a $1,000 catch-up contribution option for those between 50 and 59 ½ years old.