MANY FOLKS FIND 401(k) and 403(b) loans appealing, in part because the loans are easy to obtain and the interest that’s charged goes back into their account, so they’re effectively paying interest to themselves. But the loans can quickly lose their luster. A 2014 study by TIAA found that 29% of Americans who were participating in a retirement plan said they had taken out a loan from their plan. But 44% of those who had borrowed regretted doing so.
Why the regret? Borrowing has two costs. First, a 401(k) loan isn’t really a loan. Instead, the money you’re supposedly borrowing is actually removed from your account, which means you lose out on any investment returns the money might have earned. Second, while the money you originally contributed to your 401(k) plan came out of pretax dollars, you have to use post-tax income to repay a 401(k) loan, including the interest owed. In retirement, when you withdraw this money, you’ll have to pay taxes on these dollars again, so they’re effectively taxed twice.
Still like the idea of 401(k) loans? The good news is, they’re typically easy to apply for, with no credit check required and often no loan application fee. You can usually borrow up to $50,000 or half your account balance, whichever is less, though plans can impose stricter rules and some don’t allow loans. The money borrowed has to be repaid within five years, unless it’s used to buy a home, in which case the repayment period can be longer. Note: For 2020, those affected by COVID-19 can either borrow $100,000 or make a penalty-free withdrawal of up to $100,000 from their employer plan. The $100,000 penalty-free withdrawal can also be taken from an IRA. If the withdrawal is repaid within three years, the tax bill is erased.
If you leave your employer and don’t promptly repay a 401(k) loan, it’ll be considered a distribution and subject to both income taxes and probably tax penalties. Thinking of changing jobs? You should make a concerted effort to pay back the loan.
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