Having a 401(k) plan for your retirement income is the very good idea, and most of you may already have your 401(k) account which was set by your employer or the company for which you are working with. 401(k) account is meant for your retirement income, but still sometimes because of urgent financial necessities you can opt for borrowing money from your 401(k) account.
When you opted to borrow a loan from your account, there are certain pros and cons of it. The first thing you should understand that you can only borrow loan from your 401(k) plan if you are working with the employer who has set your account, and it's necessary to mention here not all the 401(k) plan used to offer the loan.
It is always advisable to know the terms and rules of your 401(k) plan, and you can do so by contacting plan administrator or human resource department, you can find the contact details in your annual account statement.
And once you get to know that you are eligible to borrow loan from your 401(k) plan then you should also consider the pros and cons related to having a loan from your account, in this article, we will discuss such pros and cons related to loan from your 401(k) account.
Advantages of Having Loan From Your 401(k) Account
- You don't have to fill the application form to get the loan.
- The minimum credit score is not required as technically you are borrowing the money against your account only.
- You will repay the loan amount through the automatic deductions from your paycheck, and maximum loan repayment tenure is of five years.
Disadvantages of Having Loan From Your 401(k) Account
- You have to pay the double taxation as you are also paying the tax on the loan amount which you have borrowed with after-tax money. In case you have not borrowed the money from your account then you don't have to pay the extra tax on it as it was in your account and with time it will also grow and when you withdraw any amount you have to pay tax on that amount only. But when you borrow that money, you have to pay taxes on it, and with interest, you have to put the money back into your 401(k) plan. And when after your repayment when you withdraw that money again you have to pay the taxes on the amount withdrawn, and that's why you are paying the double taxes on the same money, and this also fails the purpose of having tax-deferred 401(k) plan.
- You may have to leave your employer and the loan is still repaid then whatever is outstanding in your loan amount will be considered as taxable distribution until you pay it within sixty days.
- If you already used your 40(k) money in the form of loan to pay the debts, and you end up filing the bankruptcy then you already used up your money to pay debts, but this money should have been protected for your retirement income, and you should always understand that 401(k) money is protected from creditors and bankruptcy.
Why People Use To Borrow Money In The Form of Loan From Their 401(k) Plan
Many studies and research show that people use to borrow money from their 401(k) without any solid reasons, and it is found that they are not so good reasons as below you will get to know:
- To buy a new car or other personal expenses.
- To invest in new start-ups.
- Most of the time the borrowed money is used for children fees, or for family expenses and other needs.
- Most of the times the borrowed money in the form of loan is used to pay off the earlier debts.
And when you borrow money from your account for the above reason, then these are a bad idea to borrow money from your account. 401(k) plan is meant for the retirement income, and by doing so, you are hurting your plans when this money will be badly needed to you.
Why And Who Should Borrow Money From Their 401(k) Plan
You should always understand that the 401(k) plan money is always protected from creditors, and when you borrow that money, you are only void out the protection. You should always consider other options available to you, before opting to take the loan from your 401(k) account.
In case you feel that you will be able to handle the money well and you are sure about is the job of where you are taking the loan from your 401(k) account then you should go for it.
Many people have opted for the 401(k) loan and fund their other businesses, and they have also repaid the loan amount within the specified time, so they are growing on both the sides in their business and using their 401(k) money in the form of loan very efficiently.
Why And Who Should Not Borrow Money From Their 401(k) Plan
If you have decided to borrow money through the 401(k) plan to pay off the debts, then you might fall into the worst possible situation, and it can always be avoided.
The imperative thing to keep in mind is that when you pay off the current debt but still you are not able to manage your finances then you should not borrow the money from your account. You should understand that your 401(k) money is always protected from creditors and bankruptcy, and if the situation arises that you have changed your job and you won't be able to repay the loan amount then you will be subjected to penalties and other related taxes, and your balance amount will be considered an early distribution.
So, you should always think before borrowing money from your 401(k) plan; you should always consider all the options how you are going to pay off the loan amount. And if you opted to borrow money from your plan, then you should always maintain all your finances in order and follow the absolute commitments.
Other Options & Alternatives For Borrowing Money From your 401(k) Plans
Most of the 401(k) plans allow you to have 'hardship withdrawals' for many situations like medical expenses or to prevent eviction. If you have opted for the hardship withdrawals, then you have to pay the taxes only on the amount which is withdrawn in that financial year.
If you want to borrow the money from your 401(k) plan to pay off the debts then in that situation you have to sit with your creditors, and you should discuss with them the debt repayment plan. And don't let your 401(k) account to fail to protect you from creditors and bankruptcy.