How to Determine if Should Borrow Against 401(k)?
If you’re thinking about borrowing from your 401(k), consider the pros and cons first.
Borrowing against your 401(k) is generally frowned upon, but in some circumstances, it can make sense.
When you take out a loan from your 401(k), you don’t have to fill out a lengthy application, the interest rate is typically lower than it is for a personal loan or business loan, and there aren’t any penalties.
A big downside of borrowing against your 401(k) is that it harms your retirement saving potential. During the repayment period, you are barred from contributing to your 401(k).
This article is for business owners and professionals who are thinking about borrowing money from their 401(k) retirement fund.
Ask most financial advisors about borrowing from your 401(k), and their response will be brief and blunt: “Don’t do it.”
Those three words mostly sum up the prevailing sentiment on the subject. Still, there are some situations in which borrowing from your 401(k) might make sense. If you’re considering taking out a loan against your plan, know the pros and cons first.
Before you begin the process of borrowing against your 401(k), you need to think through the strategy. Here are some questions you should ask yourself before proceeding:
Am I eligible?
The answer depends on your employer’s plan. Employers are not required to allow loans against retirement savings plans. Some plans don’t, while others allow multiple loans. Most, though, have a minimum amount you are allowed to draw from your 401(k). Check with your plan administrator, or read your summary plan description to find out if a minimum applies and, if so, what that amount is.
How much money can you borrow?
Minimum loan amounts vary, but the maximum is $50,000 or 50% of your vested balance – whichever is less. Vesting rules also vary, so check with your plan’s administrator.
What is the cost?
In addition to the money you lose by reducing your earning potential (more on that later), you must pay interest. However, the interest rates on 401(k) loans can be very attractive compared with those for other borrowing options .
How long before I must repay?
Typically, you must repay in one to five years, unless the loan is for the purchase of a primary residence. A repayment schedule will be part of the loan agreement. For details, check your plan.
Key takeaway: Before you begin the process of borrowing against your 401(k), find out whether your plan allows it, how much you can borrow, what the interest rate is and how long you have to repay.