When done carefully, taking a loan from your 401K can be quite helpful, but there are limits. Early withdrawal from your 401K will have penalties, and your contributions will have to be repaid to replenish your plan.
Overview
The 401k plan is a retirement option that is offered by many employers that gives you the ability to make pre-tax contributions from your salary. Many employers also provide what is called matching, putting the same amount of money into your 402k dollar for dollar up to a certain amount, in most cases. There are vesting rules involved that govern this, defining when the matched amounts become yours fully. The policy is different depending on the employer, and usually specifies a number of years that you must be employed by your company to truly own your plan.
It is possible to borrow money from your 401k plan as well. That said there are some things that you should be familiar with before you decide to.
Borrowing Out of Your 401k Plan
The maximum numbers that you can borrow out of your 401k plan is considered to be either 50% of your total holdings, or a sum of $50,000 depending on whichever is the smaller number. The unique thing about this type of loan is that there isn't a required credit check, because you are really only borrowing money from your own self. This is an excellent feature that can come quite in handy considering how common it is to run into a situation where it is near impossible for you to obtain financing or lending from some other avenue, unless you should happen to have credit that is near perfect.
The interest rate for such a loan, which is going to be prime with an added 1 percent in most cases, is going to be set by the employer that the 401k is with. The repayment term, which will also be set by your company, is traditionally 10 years though it may be different depending on your employer and your needs. When you borrow for the purpose of a mortgage's down payment, you can actually expand the term of this 401k loan for as long as 30 years.
Repayment of your 401k Loan
Once a loan has been taken out from your 401k plan, you are going to have reduced the sum that is available to you upon retirement. The amounts for repayment are going to be deducted out of your paycheck following taxes. Your employer may also put some limitations on the contributions that you make to your 401k or they may stop them all together until you have repaid the loan fully. You need to understand these things so that you can make sure that your loan does not get in the way of saving for retirement.
Photo Credits: Susan NYC
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