Whether you should take a 401(k) loan depends on your situation. Learn the rules for borrowing from a 401(k) as well as the dangers so you can decide whether to take a 401(k) loan.
Money Girl
191 MG Should You Take a 401(k) Loan?
[MUSIC PLAYING] Now at T-Mobile, get four 5G phones on us and four lines for $25 a line per month when you switch with eligible trade-ins, all on America's largest 5G network. [MUSIC PLAYING] Minimum of four lines for $25 per line per month without a paid discount using debit or bank account, $5 more per line without auto pay, plus taxes and fees and $10 device connection charge. Phones would be a 24-monthly bill credits for well-qualified customers, contact us before canceling entire accounts to continue bill credits or credit stop and balance on a required finance agreement to bill credit and send if you pay off devices early, ctmobile.com. T-Mobile 5G internet keeps getting better. Boost your connection to harder to reach places with home internet plus and get internet right where you want it. With Wi-Fi that reaches the attic, I finally have a home office. Get a free upgrade to T-Mobile Home Internet Plus while supplies last. Home Internet Plus starts at $50 a month without a pay in any voice line. Check availability at T-Mobile.com/home internet. [MUSIC PLAYING] During congestion, customers on this plan may notice speeds lower than other customers and further reductions using greater than 1.2 terabytes per month due to data prioritization. After $20 bill credit, plus $5 per month without autoback, debit, bank account required. Regulatory is included for qualifying accounts. $35 connection charge applies. [MUSIC PLAYING] Hi, everyone, and welcome back to Money Girl's Quicken Dirty Tips for a richer life. I'm Laura Adams. In last week's show, I told you about the limited situations in which you're allowed to take a withdrawal from a workplace retirement plan, such as a 401k or a 403b. I mentioned that taking a loan from these types of plans might be a better option in some cases. However, taking a loan from your retirement account isn't necessarily a wise decision either. We'll take a look at the potential dangers and the rules for borrowing from your workplace retirement account. The first hurdle to getting a loan from your 401k or 403b is that it's only allowed if your employer's plan permits it. You'll find the rules and benefits of your retirement plan in the summary plan description document, which you should receive each year. Or you can just ask your benefits administrator if loans are allowed. Due to the paperwork and time that's usually required to administer retirement loans, it's been my experience that small companies usually don't offer them. If you can borrow from your retirement plan, there's a ceiling on how much it can take out. You're generally limited to borrowing no more than 50% of your vested account balance, up to a maximum of $50,000. So if you have $10,000 that's vested, you can only borrow a maximum of 5,000 or 50% of your account. Your vested balance is the amount of money in the plan that you own. You're always fully vested in your contributions, but amounts from your employer, such as matching funds or profit sharing, are usually subject to a vesting schedule. An employer could vest their contributions after you've been employed for a certain period of time, such as one or two years, that's known as cliff vesting, or they could offer graduated vesting, where you receive 20% each year over a five year period, for example. Money that you borrow from your 401k or 403b is penalty free if you follow all the rules, but it's not interest free. The interest you pay gets added to your account balance, and the rate is specified in your plan document. The loan plus interest must generally be repaid within five years. The loan payments are usually withheld from your paycheck on an after-tax basis in level amounts over the life of the loan. Taking a loan from a 401k or a 403b can be a better alternative than taking a hardship withdrawal because you're allowed to make new contributions to the account while you repay the loan. You might remember from my previous podcast that a hardship withdrawal is very different from a loan because it can't be repaid and usually comes the six month waiting period where you're prohibited from making any new contributions. Not only can taking a loan from your 401k or 403b leave you with less money for retirement, but it can also put you in a tight spot if you leave your employer or get fired before the loan is fully repaid. If you're younger than 59 and a half and lose your job while you're repaying a loan, the entire outstanding balance is due right away, usually within 60 to 90 days. If you don't pay the entire loan back by the due date established in your plan, the outstanding balance is considered an early withdrawal subject to ordinary income tax plus a 10% penalty. So be sure that all is well with your job before you decide to take a retirement account loan. Another disadvantage to taking a loan from your retirement account is that the interest you pay isn't tax deductible. If you plan to use the money to pay for education or to buy a home, for instance, you'd be better off getting a student loan or a mortgage. That's because a mortgage, a home equity loan and a student loan all come with a tax deduction for the interest you pay, which allows you to reduce your taxable income and save money on taxes. Additionally, the interest rate on a mortgage or a student loan may be lower than the interest rate you have to pay back to your retirement account in some cases. In addition to paying interest, when you take a loan from your retirement plan, you'll probably also suffer a loss in earnings by taking the money out. Here's an example. Let's say you borrow $5,000 from your 401(k) and miss out on the 6% growth on those funds. If you have to pay 7% interest on the loan when you repay the money back to your account, you might think that the additional interest you're adding in would be enough to cover your losses. However, if you repay the loan on time and have another 35 years to go before retirement, it's likely that you'd still miss out on over $8,000 of growth in the account. If something unforeseen happens and you don't repay the loan on time making it an early distribution, you'd face income taxes plus a 10% penalty. In that case, you could potentially come up short by over $47,000 by the time you retire. I used a 401(k) loan calculator to get these numbers. You can go to moneygirl.quickanddirtytips.com for links to everything that I mentioned in the show plus additional resources. Use a 401(k) loan calculator to easily run the numbers for your situation to see the long-term consequences of taking a retirement account loan. Nearly a billion people experienced hunger last year and organizations on the front line need support. That's why at Global Citizen Festival, Citi announced a new commitment supporting World Food Programs Mission and you can help. Citi will match donations to World Food Program up to $250,000 until December 1st or until we reach our goal, whichever comes first. Visit wfpusa.org/citi to make a donation and double your impact. For the love of making a difference, for the love of progress, Citi. - Saving for a lifetime? Investing for the first time? Becoming debt-free? You can do anything you put your money to. Learn how to make your money work harder with money, career, and investing tips in our women talk money community. Plus, get in on free events and candid combos. Join today at fidelity.com/womentalkmoney. Investing involves risk, including risk of loss. Fidelity broke with services member NYSE SIPC. I love learning and anything that makes learning easier. If you're a parent and your child needs some homework help, then Ixcel is a right for your family. Ixcel is an online learning program for kids covering math, language arts, science, and social studies. Ixcel has interactive practice problems for topics from pre-K to 12th grade and everything is organized by grade and subject. As kids practice, they get positive feedback, awards, and explanations for wrong answers. Ixcel figures out what your kids need more help with and recommends more topics to practice. Their videos, lessons, sample problems, and learning games too. One subscription to Ixcel gets you all subjects and all grade levels. Membership started just $9.95 a month. It's no wonder Ixcel is used in 95 of the top 100 school districts. I think the positive feedback that Ixcel gives is really crucial when it comes to learning. So make an impact on your child's learning. Get Ixcel now, and money girl listeners can get an exclusive 20% off Ixcel membership when they sign up today at Ixcel.com/moneygirl. Visit Ixcel.com/moneygirl to get the most effective learning program out there at the best price. Whether you should take a loan from your 401k or 403b, it depends on your circumstances and how you plan to use the money. Let's say your job is secure and you're younger than 59 and a half. If you were to take a loan from your 401k at 7% interest, that would be a better option than taking a hardship withdrawal and paying income tax plus a 10% penalty. A loan allows you to return the money plus the extra interest to the account so it keeps working for you over time. However, as I demonstrated, taking a loan can reduce your earnings and the total amount that you'll have for retirement. A quick and dirty tip is to consider all your other options such as getting a mortgage, a home equity loan, a student loan, or even using money in your IRA before you borrow from your 401k or 403b. The rules for taking early distributions from an IRA are different than for a workplace retirement plan. You can withdraw certain amounts of money from an IRA penalty free for some expenses such as higher education or to buy or build your first home. I'll include a link to IRS Publication 590 if you wanna find out more about taking an IRA withdrawal. Come on over to the MoneyGirl Facebook page where I post money tips, news, resources, and other stuff I'm doing. You can follow me on Twitter under the username, Laura Adams, and also sign up for the weekly MoneyGirl newsletter. If you like the podcast, be sure to subscribe or submit a review in iTunes. And as always, I love getting your email questions at money@quickanddirtytips.com. I'm glad you're listening. Cha-ching. That's all for now. Courtesy of MoneyGirl, your guide to a richer life. (upbeat music) - Hey, it's Laura Coats, host of the Laura Coats Show, on SiriusXM POTUS. When we go beyond the soundbite, we break down everything. Politics and the law and pop culture, it's what you care most about. You can listen to the Laura Coats Show at home where anywhere you are, no car required. Download the SiriusXM app for over 425 channels, an ad-free music, sports, entertainment, and more. Subscribe now and get three months free. Offer details, apply. - When you need meal time inspiration, it's worth shopping king supers. For thousands of appetizing ingredients that inspire countless mouth-watering meals. And no matter what tasty choice you make, you'll enjoy our everyday low prices, plus extra ways to save, like digital coupons worth over $600 each week and up to $1 off per gallon at the pump with points. So you can get big flavors and big savings, king supers, fresh for everyone, fuel restrictions apply.