One of the most common questions we receive from 401k participants is whether or not it is a good idea to take a loan out from their 401k plan account. I applaud those that take the time to ask this question first and not rush to a decision without taking all the data into consideration.
We’ll review when it may be good to consider a 401k loan, and when you may consider not taking a 401k loan as well as various pros’ and con’s to consider. Once you have all the data and determine how it may impact you, then you can make an educated decision on whether or not it is a good idea to take a loan out of your 401k plan account.
Before I go into the details, lets cover some basics first. Your 401k account is an important and effective savings vehicle that is vital for your retirement income needs. First you need to confirm if your company’s plan allows for a loan. Not all plans do. Keep in mind you are borrowing money from yourself and not another type of lender like a typical loan. With your plan’s loan policy statement you will be able to identify the provisions of taking out a loan and the details you need to follow. Majority 401k loan provisions require you to repay the loan amount with some type of applied interest rate (most common is current prime interest rate +1%). Currently, the prime interest rate is at 3.25%, so that plus 1% would make your applied 401k loan interest rate 4.25%. If you are not sure, you can consult with your HR team or your plan’s advisor to review the details with you.
Most loan provisions have a $1,000 minimum loan amount and allow for a maximum loan amount up to 50% of your vested account balance, not to exceed $50,000. Keep in mind these amounts are only taking your vested account balance, which is the portion of your account balance that is currently fully yours, into consideration. Your employee deferrals are always 100% and the employer portion of your account balance may only be partially vested. You would need a vested account balance of $100,000 to take out the maximum loan amount of $50,000.
Another provision to understanding is the loan pay back period. You must pay back the loan within five years. Your loan provisions may allow for an extended period if the loan is for the purchase of a primary residential home (key work is primary!).
Now that we got some of the basics out of the way, let us now talk about when you might possibly consider taking a loan from your 401k account. First and foremost, it is important to maintain these assets for their true purpose, your retirement!! But we do understand that unforeseen circumstances can happen.
Really, we want you to think of tapping into your 401k account as a last resort option. Here are some thoughts on why you might not consider a loan and cons to take into consideration.
Be sure to do your due diligence and determine if there are any other options available outside of taking a loan from your 401k plan. Here are some ideas to consider first.
Be prepared that the risks and disadvantages of taking a 401k loan may outweigh the advantages. If you are ever in doubt, please do not hesitate to call us to walk through your scenario and see what the best option may be for your specific situation. As you can see there are many pros and cons to consider and having the opportunity to talk it through with a financial professional is a great option you have available to you.
Please contact your Henry+Horne Wealth Management advisor with any questions.
Andrea Donaldson is Vice President of retirement plans for Henry+Horne Wealth Management. She can be reached at AndreaD@hh-wm.com or 480-483-3489.