Money is tight right now, and Ellen is having a hard time paying her bills. She has been thinking about taking a loan from her 401(k) account but isn’t sure if it’s the right thing to do.
A retirement plan loan has both pros and cons. On the plus side, the loan process is quick and easy. Another plus is that the loan “interest” Ellen is charged will be redeposited in her plan account. Also, the loan won’t have an impact on Ellen’s credit rating because 401(k) plans don’t report loan activity to credit rating agencies.
On the negative side, Ellen will have to pay income taxes on the earnings she uses to repay the loan. This means her money will be taxed twice — once when she earns it and pays back the loan and again in the year she receives taxable distributions from her plan. Ellen should also be aware that the plan will have limits on how much she can borrow, and a fee may be charged in connection with the loan.
Another important point Ellen should consider: She will sacrifice potential opportunities for investment growth, since the money she’s borrowed will no longer be invested while the loan is outstanding. In addition, if Ellen leaves her employer, the outstanding loan balance likely will be due shortly after separation and will be subject to income taxes and possibly a 10% penalty if not repaid promptly.
Consider all your options and weigh the pros and cons carefully before making a decision about borrowing from your retirement plan.
Client Profile is based on a hypothetical situation. The solutions we discuss may or may not be appropriate for you.
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