On top of the potential long-term problems resulting from default, Centeno points out that if you leave your job (or if you’re laid off), the balance of your loan is due by your tax filing date. “That’s a big blow.” You might inadvertently accelerate the repayment period “When you don’t pay back your 401(k) loan, you’re subject to taxes and a 10% penalty if you’re under the age of 59 ½,” says Bergman. That could be a big blow to a saver - especially if you can’t contribute to your 401(k) while you have an outstanding loan. Bergman points to study from Deloitte, indicating that defaults might drain as much as $2 trillion from Americans’ 401(k) account balances over the next 10 years.įor a typical borrower, this could mean a loss of $300,000 in retirement security over the course of a career. One of the biggest concerns with borrowing from your 401(k) is the fact that you just might not pay off the loan. Why 401(k) loans are risky You might not pay it off Just because there are advantages, though, doesn’t necessarily mean using a 401(k) loan is a good idea. For some borrowers, it’s possible to get a lower rate than they would otherwise qualify for. Additionally, depending on the policies associated with your plan, you might not have to worry about strict credit criteria. Plus, because of the short time frame, you know you’ll be able to pay off the loan quickly, says Centeno, potentially faster than you would be able to otherwise. “It can be a smart decision and save a significant amount of interest.” “The interest rate on a 401(k) loan is fixed and significantly lower than outstanding credit card interest rates,” says Centeno. The biggest advantage to using a 401(k) to pay off credit cards or other high-interest debt is the relatively low rate. Advantages of borrowing from a 401(k) to pay off debt He also points out that the interest rate on the loan has to be at least the prime rate, although it can be higher. How long do you have to pay it back?įor the most part, 401(k) loans come with a repayment term of five years, according to Bergman. At that point, she says, you can borrow up to $10,000 from your 401(k). The exception is if your balance is $10,000 or less. When borrowing from a 401(k) to pay off debt, says Christine Centeno, a CFP and the owner of Simplicity Wealth Management, you’re limited to the lesser of: You miss out on compounding returns while the money is out of your account.You might not be able to contribute to the 401(k) while you have a loan balance.Defaulted loan amounts are treated as distributions, with accompanying taxes and penalties.If you leave your job, you have to repay the balance quickly.As long as you meet the terms of the loan, you won’t have penalties and taxes.You repay interest to yourself, putting more back into the 401(k).Check with your human resources department to find out how to borrow from your 401(k) and what terms you might be stuck with. For example, you may not be able to keep contributing new money to your 401(k) until after you pay off the loan. Additionally, among companies that do offer a plan, you might have restrictions. Not every plan offers a loan option, though. “You repay the money back into your 401(k), including paying interest to yourself.” “Using a 401(k) plan loan option allows you to use your retirement savings for any purpose, including paying off debt,” says Bergman. What is a 401(k) loan?Ī 401(k) loan is what it sounds like - you borrow money from your 401(k) for any purpose, and then you repay it. Before you decide to put your future at risk, it’s vital to know what you’re getting into. However, while there are some advantages to dipping into your retirement savings to pay off debt, there are some downsides. “It feel like the only real option for paying off debt.” “For some people, the 401(k) plan is the largest pool of saving,” says Adam Bergman, a tax attorney and president of both the IRA Financial Group and IRA Financial Trust Company. You might even begin to think that borrowing a 401(k) loan to help you get out of debt makes a lot of sense. Debt can weigh you down until paying it off as quickly as possible becomes almost an obsession. In fact, most Americans are in debt, according to a recent analysis by Nitro. Many of us are struggling with how to pay off debt.
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