If you have found yourself in financial distress whether from unexpected expenses, job loss, or high unsecured debt, and you do not have access to a personal loan or other sources of capital, you may be wondering should you borrow against your 401k?
If you are considering this option, there are several factors that you should consider. Perhaps the main consideration should be if accessing your retirement funds will really fix the initial problem. Many times, people jeopardize their financial future by withdrawing funds from their retirement account while never really solving the problem in the first place.
By taking a long honest look at how you got into a financial jam in the first place, you can better avoid similar situations in the future. Online broker ETrade offers budgeting calculators and other financial tools to help you formulate and stick to a budget, pay off debt, and invest for retirement.
Should You Borrow Against Your 401k?
Should you borrow against your 401k? It is almost always better to borrow against your 401k then to make a withdrawal. Withdrawals from a 401k are subject to high taxes and early withdrawal penalties which are required to be paid during the same year the money was withdrawn in.
You may qualify for a hardship withdrawal under your plan’s guidelines, but you must be able to prove a qualified financial situation prior to receiving this type of distribution. Early withdrawals from your 401k account – withdrawals made prior to turning 59½ – are subject to a required 20% withholding from your employer for federal taxes, your personal income tax rate, and an additional 10% penalty.
It is not difficult to see how these taxes and fees can quickly add up, leaving you with far less capital than you may have hoped for. You will also not be allowed to make catch up contributions at a later date.
Depending on your plan’s rules and regulations, by borrowing against your 401k you will not have to pay taxes or penalties on the funds withdrawn, you must simply pay back the funds with interest. When you borrow against your 401k you will lose the funds that your 401k would have accrued during that time, but you will not lose additional funds as long as you pay the funds back within the allotted time frame.
Consider All Of Your Options Before You Borrow
Should you borrow against your 401k? Even if your employer’s plan allows for you to borrow against your 401k, you should still research other options to find out if there is a more cost-effective way to secure capital.
It is important to consider all of your options including refinancing your home, or taking out a personal loan. Your goal is to assess the benefits and drawbacks to your various options and decide which one is the most cost-effective in the long run.
Consult with a professional financial adviser such as the professionals at online broker ETrade to develop a plan that works best for you. If all of your options offer you similar long-term costs it is advised to go with a different option than borrowing from your 401k account.
The main risk in borrowing from your 401k account lies in the possibility that you may lose your job, and the entire loan amount will come due within 60 days. Failure to comply with these rules will result in the entire amount borrowed being subject to taxes and penalties.