The pros and cons of a taking out a 401(k) loan

401(k) contributions are tax-deferred until withdrawn
Published: Aug. 8, 2023 at 12:32 PM PDT
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(InvestigateTV) — The latest Census report shows 34.5% of Americans have a 401(k)-style retirement plan, many of which allow loans for participants.

Although not mandatory, some 401(k) plans do offer loans. These loans are subject to various conditions, such as a maximum term of five years, among other requirements.

Cherry Dale, a financial coach with the Virginia Credit Union, said it’s always better to consider a loan over actually withdrawing from your 401(k).

“Most employers will let you borrow up to $50,000 dollars or 50%, whichever is more of your 401(k), you would have around five years to pay that back,” Dale explained. “Now, the sooner you can pay that back, the better off you’re going to be, because the money that you pull from your 401(k) is obviously not going to be invested at that point.”

Dale explained the interest paid on 401(k) loan installments is reinvested into the original account, which means that the plan holder is, in effect, paying themselves interest.

However, she said the amount borrowed from the plan will not be invested during the term of the loan, meaning the plan participant will miss out on any market gains or losses during the loan term.

“You got to weigh all of the pros and cons about it. But, you know, if you’re in a dire situation, or you’re needing that college tuition or things like that and you have no other place to go, that might be a better avenue versus a credit card or a personal loan,” Dale said.

Since 401(k) funds are tax-deferred, there are specific Internal Revenue Service (IRS) requirements for repayments, including penalties for not repaying the loan.

If a borrower quits their job or changes employers during the loan term, the loan may become taxable if not repaid before the end of the fiscal year.

Dale said 401(k) loans may be a good option for people who need money quickly for things like medical expenses or even college tuition and urged people contemplating loans to consult with their financial advisor.

The IRS has further information on retirement loan programs. For individualized help, contact your 401(k) plan administrator.