A 401k plan is a qualified plan established by employers to which eligible employees may make salary deferral contributions. 401k retirement plans are very popular in the United States of America. The first version of this plan was created by Ted Benna. 401k plan was created to encourage people to save for their retirement. These plans also help employees save on taxes.
Many employers allow their employees to borrow money from their 401k retirement plans. They are considered as a source of low cost borrowing in the U.S. An employee may borrow up to $50,000 or 50% of the total 401k value (which ever is smaller). The employee may repay the loan faster without any prepayment penalty. This loan will not have any impact on the employee’s credit score. But financial experts advise employees against borrowing from their 401k plans. Some are of the opinion that it is like robbery. Those funds should not be touched except in cases of extreme emergencies.
There are many disadvantages of borrowing from 401k plans. The main disadvantage is that the employee’s take home salary is reduced. 401k loans are repaid through payroll deductions. Some 401k retirement plans do not allow the employee to contribute until the loan is paid in full. Also the employee will be losing the interest that the borrowed money could have earned. This results in diminished future earnings.
If an employee leaves the job before clearing the 401k loan, he/she is given a 60 day time period. If the employee does not pay within this time period, the loan is considered as an early 401k withdrawal. The employee will be penalized (10% penalty on the amount of the loan) for withdrawing money from retirement savings before it is allowed. The employee should be more than fifty nine and a half years old to be able to withdraw without penalty. The employee has to report the amount of withdrawal (in the tax return) as taxable income.
The 401k loan term is usually five years. Loan balances that are outstanding after the loan expiration date are subject to federal and state income taxes. The interest on the loan is not tax deductible. Many 401k plans charge a fee (ranges from $5 to $100) for taking the loan.
Employees should weigh the advantages and disadvantages of borrowing from their 401k plan. It is advisable to avoid borrowing from 401k plans. Retirement calculator may help employees take wise decisions.