Have you thought about taking a loan from your 401k? While we all have the dream of working hard to someday enjoy retirement, you may encounter an unexpected emergency along the way.
But is taking a loan from your 401k a good option?
Consequences of taking a loan from your 401k
Sometimes you just need money for an emergency or to take advantage of an opportunity. If this is your situation, here are the consequences to keep in mind.
- When you take a loan from your 401k, you have to repay those dollars within a 5-year period. The longer you stretch out repaying the loan in full, the worse off you’ll be by the time you hit retirement because of the missed time of having those dollars grow.
- The money you use to repay your loan will be taxed and deducted from your paycheck. Then when you retire, you’ll pay taxes on those dollars again. Yes, you will be taxed TWICE on dollars you use as a loan from your 401k! This will significantly slow down your retirement plan growth while you’re repaying the loan.
- If you leave your employer while repaying a 401k loan, you’ll need to repay the loan more quickly or be penalized. If you’re unable to pay it in full by the 15th of the month following the quarter in which you left the company, the remaining loan amount will be considered a distribution and you’ll have to pay ordinary income taxes on those dollars.
- If you’re younger than 59 ½ years old when taking out a loan, you’ll also be subject to a 10% IRS penalty. Except under specific circumstances, you will be penalized for taking money out of your 401k. Stack this on top of federal and state taxes and you’re looking at a harsh price tag for your emergency loan.
How to prevent taking a loan from your 401k
The goal is to get to retirement and do whatever you want, wherever you want. In order to do that without losing some of the money you’ve worked so hard to build in your 401k, follow these two bits of advice:
- Have emergency reserves. Save a little extra money each paycheck to maintain at least $1,000 in the bank for any “what ifs” that may come your way. From there, build a reserve for 3-6 months’ worth of expenses.
- Eliminate debt. Make this the year to become debt-free! This is the one area that makes most people take a 401k loan, and it prevents them from having enough money saved in their account when they reach retirement. Create a plan and stick to it!
If you can build an emergency reserve, eliminate debt and live within your means, you will successfully avoid touching your 401k dollars until you reach retirement.
For 401k questions or advice, please contact 401k Advisors Intermountain at (801) 559-7774 or email retire@401kaim.com.
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