Borrowing against your 401k

During this period of financial hardship in the global economy and in the United States many workers are looking for additional sources of income. Those with a 401(k) retirement plan may consider taking out a cheap loan against their retirement savings, or even on outright distribution.

Taking a loan against your 401(k) should be your last option when looking for additional resources, but there are a few reasons to consider this option:

* Serious financial difficulty

Unfortunately there are times in life that serious financial difficulty can force people to do things they wouldn’t otherwise wish to do. Medical emergencies are a common such problem. When there is simply no money for these types of situations taking a cheap loan on your 401(k) could be an option.

* Other alternatives are financially damaging

There are times when other resources are available, like payday loans, but it still makes more sense to take a cheap loan on your 401(k). The reason for this is the rather high interest rate that these other loans will charge you. A 401(k) loan generally has a very low interest rate, at or near prime in most cases. As far as fees, 401(k) loans often have very small or no fees.

There are some additional benefits to taking a 401(k) loan as well. There is no credit check required on these cheap loans. This is your retirement fund, this is your money that you are accessing, you aren’t technically taking credit. Additionally, the interest that you pay to these loans goes back to you. That’s right, the interest you pay gets paid into your 401(k), so you are really paying yourself interest to take out this cheap loan.

Remember that there are also a few restrictions on 401(k) loans, they shouldn’t be used for anything but emergencies. There is a limit to how much you can borrow: One half of your retirement funds, up to $50,000. And repayment generally begins on your next pay date. You typically must repay the balance within five years, although often you are given the choice to pay the loan off as quickly as you would like.

* Last Resort?

So, why should this be your last resort?

You are taxed on the money you use to repay the cheap loan, so paying $25 back to your loan means your pay is reduced by $25. Not at all like the pre-tax deposits you initially made into your 401(k). Although this money goes right into your 401(k) you have already paid taxes on it, and when you withdraw it from your plan you will pay taxes on it again.

In the event that you cease employment for any reason if you can’t pay back the loan within 60 days it is generally treated as a distribution. That means that you must pay taxes and often penalties and fees on the amount that you borrowed and could not repay.

Finally, when you borrow from your 401(k) you are giving up the tax free compounding that that money would otherwise be earning you. Those funds are no longer working for you for your retirement.

There are times where it makes sense to borrow from your 401(k), especially if your only other alternative is to take a distribution, but this should be your last resort. Consider your options carefully and see if there are any other sources of money before tapping this valuable retirement tool.