How Does a 401K Loan Work and What are the Pros and Cons of a 401k Loan?
Most employers provide access to the 401K plan with a loan option. Please be advised, accessing your 401k for loans is typically not advised; unless necessary to avoid a financial hardship, particularly because it hurts the ability for you to continually save for your retirement, which is the main reason your 401K was created.
There are many appetizing features to a 401K Loan. A person can borrow up to 60 months or 5 years. The amount they can borrow is between $1000 to $50,000. The amounts may differ, depending on your employers 401K loan rules and regulations.
In many cases, the interest rate will fluctuate with the amount of the loan. The employer has some flexibility here and can set the interest rate, but the rate must be comparable to the going market rate. Meaning, they cannot increase the interest rates to an unrealistic amount.
401K loans are typically paid back through payroll deduction by the accounting department of your employment. These payments are automatic and paid back into your 401K.
During financial hardships, a person’s credit score can take a hit and it is hard to pass the preapproval on loans. 401K loans do not require a preapproval or credit/background checks.
Before speaking with your employer about a 401K loan, please be advised of the pros AND cons.
Pros of a 401K Loan:
• Help pay down high interest credit cards or other types of debt
• Lower interest rates (compared to credit card interest)
• Your account earns the interest rather than the bank of your credit card company
• Better than a 401k Distribution
• Funds are acquired quickly and easily
• Can be used towards other expenses such as college tuition or medical expenses
Cons to a 401K Loan:
• Loss of Investment growth. When you borrow from your plan, you are taking it out of the investments which forfeit the ability for it grow until the loan is paid
• You are borrowing money that was pre-taxed and paying it with after tax contributions. Meaning, your payments come out after taxes are assessed. Essentially, you are paying for it twice in taxes.
• It is dependent upon your employment. You are paying back the loan via payroll, if you no longer work for the employer, chances are your loan will go into default. This means you are incurring taxes and penalties on the existing loan balance.
• Missing out on saving opportunities
401k Loans can be a great thing to consider, but before you step into it, have caution and really think through why you want the loan and what purpose it is going to serve.
We are here to assist you with your planning and investing, so you can focus on living.
If you don’t currently have a plan, we’ll discuss options. If you already have a plan we’ll discuss how it is set-up and how we can improve it!
You can call us directly or visit our office too!
Hagan Newkirk | Plan, Invest, Live
Central Arkansas Corporate Office
6235 Ranch Drive
Little Rock, AR 72223
Phone: (501) 823-4637
Contact Hagan Newkirk
Telephone: (501) 823-4637
Visit our Office:
6325 Ranch Drive
Little Rock, AR 72223