What You Should Know Before Taking a 401(k) Loan

Did you know that you can take a loan from your 401(k) retirement account? If so, do you know all the implications of taking such a loan?

Either way, it’s important to briefly examine some things you should be aware of before taking a loan from your retirement account.

First things first – the fact that you even have a workplace savings accounts is a great place to find yourself. It’s one of the best and most effective ways to save for your future. While your future may be looking bright financially, sometimes you have the need to borrow some money in the present. But is this a good idea?

Here are three things to examine:

  1. It’s Not Free Money, It’s a Loan – Taking money from your retirement plan is a loan, which means it must be repaid. This means you will have to add into your budget a recurring monthly expense until the loan is paid off. Be sure that your new monthly loan payments don’t take from the amount you are saving for retirement. Also, make sure you borrow only what’s necessary and pay it back as soon as possible.
  2. Money You Borrow Can No Longer Work for You – No matter how short the time, money taken out of your retirement account on loan isn’t collecting interest or dividends; it has no potential to benefit from a rising market. Forfeiting any potential compound interest down the road makes the impact of this loan greater than you might have anticipated.
  3. You’re On the Hook Even if You Leave Your Job – In the event you leave your current job, the loan goes with you and you must continue to make your monthly payments. If you don’t have the funds to pay it back, you can default on the loan and even possibly face a 10% penalty if you are under the age of 59 1/2 and owe income tax on the outstanding balance.

Bottom line, be sure you examine all alternative options before borrowing against your 401(k). In some cases it can be a lifeline, but there are often other cheaper options to consider before going this route.


About cozbycpa

Heather L. Cozby is a CPA on the South Shore and Cape Cod. The managing partner of Cozby & Company, LLC, Heather has the resources and experience necessary to provide quality professional services on a timely basis and at a reasonable cost. She specializes in tax planning & preparation; audit, review & compilation services; management advisory services; bookkeeping; and accounting. Her unique niche is in working with homeowners’ associations and condominium trusts, advising with rental real estate, and providing outsourced financial consulting for mid-sized companies. She is more entrepreneurial than most accountants, and offers the best of both worlds - providing the services of a larger firm while retaining the ability to connect with her clients on a personal level.
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