Retirement Tips

Retirement Investing - Borrowing From Your 401k - Part 2

November 1st, 2006 by Papabear

Let’s see – 4 good reasons to borrow from your retirement account. Here are 2 good reasons not to borrow from your 401k account:

5. As the old saying goes “some restrictions apply.” Our friends in Congress and the IRS don’t want this to be too good a deal, even if it’s our own money. After all, Congress thinks they did us a really big favor with 401k accounts by making it easier to save for retirement. Maybe they did, but like many good deals, this one comes with strings attached. First there’s the $50,000 limit. Even if your have $200,000 in your 401k account, and the general rule is you can borrow up to 50% of your 401k account balance, you are limited to borrowing $50,000 at any one time. In addition most plans usually limit the number of loans you can have at any one time to 1 or 2. For example, if you borrow 50% of your 401k account balance of $50,000 on a 5 year loan, and the $25,000 left in your account triples over the next 3 years from savings and increases in the value of the investment to $75,000, you cannot borrow another $37,500. First you are limited to a total outstanding balance of $50,000. Second, if your plan restricts you to 1 loan at a time, you will not be about the borrow 50% of the new value in your account until the first loan is paid off. Even if your plan allows for 2 loans at a time, most plans have another restriction that says the amount you can borrow on the second loan will be reduced by the highest outstanding balance on the first loan during the previous 12 months.

6. If you switch to a new company, you may have to pay off your loan immediately. In many cases, this can be avoided by rolling over your 401k account, but if you can’t do that, the outstanding balance of your loan will be considered an “early distribution” from you retirement savings account and will be deducted from what you have available. You won’t have to pay the money back, but you will have to pay taxes on the balance of the loan as ordinary income. And if you’re less than 59 ½ yeas old, you will also have to pay a 10% early withdrawal penalty.

Thinking about paying extra taxes is stressful, so we’ll end here today. Tomorrow, I’ll post 2 other reasons to think twice about borrowing against your retirement account.