When is it a good idea to borrow from your 401k? Is it ever a good idea? Are there penalties for doing so? How much can you borrow? If you’ve ever wondered about these questions, you’re not alone. Keep reading for answers!
Is it a Good Idea?
Why would someone need to borrow money from their 401k? There could be any number of reasons. However, people typically borrow when there’s an immediate need for a lump sum of cash. An article written by Troy Segal for investopedia.com explains further by saying, “When you must find the cash for a serious short-term liquidity need, a loan from your 401(k) plan probably is one of the first places you should look. Let’s define short-term as being roughly a year or less. Let’s define “serious liquidity need” as a serious one-time demand for funds or a lump-sum cash payment.”
Borrowing from your 401k is a good idea when your alternative is a high interest loan. 401k loans are simple, low interest and you can access your money quickly. Additionally, it’s cheap to borrow money this way. There are no costs except for a small loan origination or administration fee. It’s a more cost effective alternative to most other loans.
Are there Penalties?
There are no penalties for tapping into your 401k money for short term investments. You will be required to repay the loan in its entirety over a five year period. However, you are allowed to pay the loan off early with no prepayment penalty. Repayment is typically deducted directly from your paycheck. Taxes are taken out of your check first, and then your 401k repayment money is deducted second. Before borrowing money, make sure you will be able to survive on the paychecks you receive after all deductions have been made.
How much can you Borrow?
You can borrow whichever is less- up to $50,000 or 50% of your 401k. Before you even start looking into taking money; however, you need to make sure your company allows you to borrow. Some do and some don’t. Make sure you read your company’s policy.
Other Advantages
When you borrow money from your 401k, you are required to pay a small amount of interest on the money. This means that when all is said and done, your retirement fund will come out ahead. You’ll have more money in there than you would have if you had never taken out the loan in the first place. While some people reject the idea of borrowing money from your 401k, it has plenty of advantages.
If you’re ever in a position where you need a large sum of money quickly, consider borrowing from your 401k. The money seems untouchable; however, loaning cash to yourself might actually save you money in the long run. As always, go through every option before making a decision. Just know, it’s your money and it’s there in the event of an emergency.