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A 60-Second Guide to Taking a Personal Loan from Your 401(k)

[Apr 21, 2009.]

 

More people are turning to their 401(k) plans for personal loans to help pay their bills. In fact, the number of Americans who took out a “hardship” loan from their 401(k) rose to 27% from 19% in the final months of 2008, according to a study by consulting firm Watson Wyatt.  


While taking out a loan from a 401(k) can be pretty simple, borrowers should exercise caution before going this route. The following guide will help 401(k) participants weigh the pros and cons of taking a personal loan from their retirement account.


There is no credit check for a loan from a 401(k) plan. The money belongs to the borrower, so they don’t have to fill out an application with a lender.


—These fast loans can be electronically transferred or mailed to borrowers in about a week in many cases. The process for getting a fast loan can be as easy as logging into a retirement account and liquidating proceeds from a money market fund. In other cases, borrowers may need to sell shares of mutual funds before the proceeds can be mailed to them.


—Generally, a person can borrow up to 50% of their vested account balance, up to a maximum of $50,000.


—Borrowers must repay the loan back to their 401(k) account plus interest, which is usually relatively low.


—People usually pay back their loan with deductions from their paycheck.


—Some employers may restrict the reasons workers can take personal loans from their 401(k). Some companies only allow loans to be used for paying for education or medical expenses, buying a home for the first time, or avoiding eviction.


—If the borrower leaves their job before the loan is repaid, they’ll have to pay it back in full or end up paying federal and state income taxes on it. People under 59 will also pay a 10% penalty. People who are laid off may only have 60 days to repay their loan.


—Borrowers usually must repay these loans within five years or be hit with penalties and taxes. But if the money is used to purchase a home, the repayment period may be stretched to 10 to 15 years.


—Taking funds out of a retirement account cuts into the amount of money a person may earn over the long term for their retirement.


—Interest on loans from retirement accounts is not tax deductible.


Getting a no credit check loan from a 401(k) can be very tempting, but unless a borrower is in dire straits, they’re usually better off finding another source of funds.

 

About Author:

Francine L. Huff is a freelance journalist and the author of The 25-Day Money Makeover for Women. She has appeared on a variety of TV and radio shows.

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