Other Options For Getting 401 Money
If you’re at least 59½, you’re permitted to withdraw funds from your 401 without penalty, whether you’re suffering from hardship or not. And account-holders of any age may, if their employer permits it, have the ability to loan money from a 401.
Most advisors do not recommend borrowing from your 401 either, in large part because such loans also threaten the nest egg you’ve accumulated for your retirement. But a loan might be worth considering in lieu of a withdrawal if you believe there’s a chance you’ll be able to repay the loan in a timely way s, that means within five years).
Loans are generally permitted for the lesser of half your 401 balance or $50,000 and must be repaid with interest, although both the principal and interest payments are made to your own retirement account. It is also worth noting that the CARES Act raises the borrowing limit from $50,000 to $100,000. If you should default on the payments, the loan converts to a withdrawal, with most of the same consequences as if it had originated as one.
401 loans must be repaid with interest in order to avoid penalties.
About two-thirds of 401s also permit non-hardship in-service withdrawals. This option, however, does not immediately provide funds for a pressing need. Rather, the withdrawal is allowed in order to transfer funds to another investment option.
Retirement Savings Can Benefit
As you make loan repayments to your 401 account, they usually are allocated back into your portfolio’s investments. You will repay the account a bit more than you borrowed from it, and the difference is called “interest.” The loan produces no impact on your retirement if any lost investment earnings match the “interest” paid ini.e., earnings opportunities are offset dollar-for-dollar by interest payments.
If the interest paid exceeds any lost investment earnings, taking a 401 loan can actually increase your retirement savings progress. Keep in mind, however, that this will proportionally reduce your personal savings.
Will Your Employer Know If You Take Out A 401 Loan
Yes, its likely your employer will know about any loan from their own sponsored plan. You may need to go through the human resources department to request the loan and youd pay it back through payroll deduction, which theyd also be aware of. Loans arent guaranteed to be approved either or your plan may not offer them at all. If youre concerned about a manager or executive finding out about the loan request, consider asking HR to keep your request confidential.
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How To Withdraw Money From Your 401
The 401 has become a staple of retirement planning in the U.S. Millions of Americans contribute to their 401 plans with the goal of having enough money to retire comfortably when the time comes. Whether youve reached retirement age or need to tap your 401 early to pay for an unexpected expense, there are various ways to withdraw money from your employer-sponsored retirement account. A financial advisor can steer you through these decisions and help you manage your retirement savings.
Is It A Good Idea To Borrow From Your 401
Using a 401 loan for elective expenses like entertainment or gifts isn’t a healthy habit. In most cases, it would be better to leave your retirement savings fully invested and find another source of cash.
On the flip side of what’s been discussed so far, borrowing from your 401 might be beneficial long-termand could even help your overall finances. For example, using a 401 loan to pay off high-interest debt, like credit cards, could reduce the amount you pay in interest to lenders. What’s more, 401 loans don’t require a credit check, and they don’t show up as debt on your credit report.
Another potentially positive way to use a 401 loan is to fund major home improvement projects that raise the value of your property enough to offset the fact that you are paying the loan back with after-tax money, as well as any foregone retirement savings.
If you decide a 401 loan is right for you, here are some helpful tips:
- Pay it off on time and in full
- Avoid borrowing more than you need or too many times
- Continue saving for retirement
It might be tempting to reduce or pause your contributions while you’re paying off your loan, but keeping up with your regular contributions is essential to keeping your retirement strategy on track.
Long-term impact of taking $15,000 from a $38,000 account balance
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Why Do People Get 401 Loans
As long as a plan allows it, participants generally can borrow from their 401 for any reason. Some plans may only allow loans for specific reasons, so be sure to check your plans rules before trying to borrow.
Since youre borrowing your own money, and no credit check is involved, it may be easier to get approved for a 401 loan as long as you meet the plans requirements for borrowing. In some cases, a requirement may be getting approval from your spouse , because your spouse may be entitled to half of your retirement assets if you divorce.
Here are some potential uses for a 401 loan.
- Paying household bills and expenses
- Funding a down payment on a house
- Paying off high-interest debt
- Paying back taxes, or money owed to the IRS
- Funding necessary home repairs
- Paying education expenses
But that doesnt mean 401 loans are always a good idea. In fact, there are some major risks that come with borrowing from your retirement savings. Here are two.
Consider All Options Before Borrowing A 401 Loan
If youre considering taking out a 401 loan, you should make sure you understand all the fees, rules and terms of the agreement before you apply. You should also consider all other options, since there are definite risks to borrowing from your 401 and digging into your retirement savings. Once youve decided on the path thats right for you, be sure to come up with a budget and savings plan to help you avoid needing to borrow in the future.
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How To Take Out A 401 Loan
If youre really in a pinch, or absolutely cant get an alternative loan source, you can take a 401 loan by talking to your human resources or benefits manager at work, or by logging into your 401 plans website.
Some plan providersincluding John Hancock and Fidelityallow you to request loans online.
Loans To Purchase A Home
Regulations require 401 plan loans to be repaid on an amortizing basis over not more than five years unless the loan is used to purchase a primary residence. Longer payback periods are allowed for these particular loans. The IRS doesn’t specify how long, though, so it’s something to work out with your plan administrator. And ask whether you get an extra year because of the CARES bill.
Also, remember that CARES extended the amount participants can borrow from their plans to $100,000. Previously, the maximum amount that participants may borrow from their plan is 50% of the vested account balance or $50,000, whichever is less. If the vested account balance is less than $10,000, you can still borrow up to $10,000.
Borrowing from a 401 to completely finance a residential purchase may not be as attractive as taking out a mortgage loan. Plan loans do not offer tax deductions for interest payments, as do most types of mortgages. And, while withdrawing and repaying within five years is fine in the usual scheme of 401 things, the impact on your retirement progress for a loan that has to be paid back over many years can be significant.
If you do need a sizable sum to purchase a house and want to use 401 funds, you might consider a hardship withdrawal instead of, or in addition to, the loan. But you will owe income tax on the withdrawal and, if the amount is more than $10,000, a 10% penalty as well.
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Hardship Withdrawal Vs 401 Loan: An Overview
Is it ever OK to borrow from your 401 plan, either as a 401 loan or a hardship withdrawal? After all, your plan is a powerful retirement savings tool and should be carefully handled. Indeed, data from Fidelity shows that the average account balance has climbed to $112,300, as of February 2020.
The recently enacted CARES Act lets you make a penalty-free COVID-19 related withdrawal or take out a loan from your 401 in 2020 with special repayment provisions and tax treatment.
The primary advantage of saving in a 401 is the ability to enjoy tax-deferred growth on your investments. When youre setting aside cash for the long term, a hands-off approach is usually best. Nevertheless, there are some scenarios in which taking money out of your 401 can make sense.
Before you pull the trigger, though, its important to understand the financial implications of tapping your retirement plan early. There are two basic avenues for taking some money out before reaching retirement age.
So What Is A 401 Loan
A 401 loan is a lump-sum disbursement from funds that you have saved in your retirement account. You must repay the loan over a fixed-amount of timewith interestback into your 401 account.
You can borrow between sixty and eighty percent of your 401 balance, and occasionally up to the full account value. The loan is set-up through your 401 plan administrator.
In some ways, a 401 loan seems like a good idea. Essentially, you borrow money from yourself, so interest charges go right back into your retirement account instead of to the bank. And, since its secured by your own money, there is no credit check to take a loan, and you cant default and find creditors knocking down your door.
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When A Problem Occurs
The vast majority of 401 plans operate fairly, efficiently and in a manner that satisfies everyone involved. But problems can arise. The Department of Labor lists signs that might alert you to potential problems with your plan including:
- consistently late or irregular account statements
- late or irregular investment of your contributions
- inaccurate account balance
Alternatives To Tapping Your 401
If you must tap into retirement savings, it’s better to look at your other accounts firstspecifically IRAsespecially if you’re buying a first home .
Unlike 401s, IRAs have special provisions for first-time homebuyerspeople who haven’t owned a primary residence in the last two years, according to the IRS.
First, look to take a distribution from your IRAif you have one. You may be able to withdraw IRA contributions without penalty due to a qualified financial hardship. You can also withdraw up to $10,000 of earnings tax-free if the money is used for a first-time home purchase. As a first-time homebuyer, you can take a $10,000 distribution without owing the 10% tax penalty, although that $10,000 would be added to your federal and state income taxes. If you take a distribution larger than $10,000, a 10% penalty would be applied to the additional distribution amount. It also would be added to your income taxes.
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If Youre Thinking About Borrowing From Your 401 Consider The Pros And Cons First
- Borrowing against your 401 is generally frowned upon, but in some circumstances, it can make sense.
- When you take out a loan from your 401, you donât have to fill out a lengthy application, the interest rate is typically lower than it is for a personal loan or business loan, and there arenât any penalties.
- A big downside of borrowing against your 401 is that it harms your retirement saving potential. During the repayment period, you are barred from contributing to your 401.
- This article is for business owners and professionals who are thinking about borrowing money from their 401 retirement fund.
Ask most financial advisors about borrowing from your 401, and their response will be brief and blunt: âDonât do it.â
Those three words mostly sum up the prevailing sentiment on the subject. Still, there are some situations in which borrowing from your 401 might make sense. If youâre considering taking out a loan against your plan, know the pros and cons first.
Editorâs note: Looking for an employee retirement plan for your business? Fill out the below questionnaire to have our vendor partners contact you about your needs.
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What Else Do I Need To Know
- If your employer makes contributions to your 401 plan you may be able to withdraw those dollars once you become vested . Check with your plan administrator for your plan’s withdrawal rules.
- If you are a reservist called to active duty after September 11, 2001, special rules may apply to you.
Important Note: Equitable believes that education is a key step toward addressing your financial goals, and this discussion serves simply as an informational and educational resource. It does not constitute investment advice, nor does it make a direct or indirect recommendation of any particular product or of the appropriateness of any particular investment-related option. Your unique needs, goals and circumstances require the individualized attention of your financial professional.
Equitable Financial Life Insurance Company issues life insurance and annuity products. Securities offered through Equitable Advisors, LLC, member FINRA, SIPC. Equitable Financial Life Insurance Company and Equitable Advisors are affiliated and do not provide tax or legal advice, and are not affiliated with Broadridge Investor Communication Solutions, Inc.
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Think About What Would Happen If You Lost Your Job
This is really important. If you lose your job, or change jobs, you cant take your 401 loan with you. In most cases you have to pay back the loan at termination or within sixty days of leaving your job. This is a big consideration. If you need the loan in the first place, how will you have the money to pay it back on short notice? And if you fail to pay back the loan within the specified time period, the outstanding balance will likely be considered a distribution, again subject to income taxes and penalties, as I discussed above. So while you may feel secure in your job right now, youd be wise to at least factor this possibility into your decision to borrow.
Smart Move: To lessen the odds of having to take a 401 loan, try to keep cash available to cover three to six months of essential living expenses in case of an emergency.
When A 401 Loan Makes Sense
When you mustfind the cash for a serious short-term liquidity need, a loan from your 401 plan probably is one of the first places you should look. Let’s define short-term as being roughly a year or less. Let’s define “serious liquidity need” as a serious one-time demand for funds or a lump-sum cash payment.
Kathryn B. Hauer, MBA, CFP®, a financial planner with Wilson David Investment Advisors and author of Financial Advice for Blue Collar America put it this way: “Lets face it, in the real world, sometimes people need money. Borrowing from your 401 can be financially smarter than taking out a cripplingly high-interest title loan, pawn, or payday loanor even a more reasonable personal loan. It will cost you less in the long run.”
Why is your 401 an attractive source for short-term loans? Because it can be the quickest, simplest, lowest-cost way to get the cash you need. Receiving a loan from your 401 is not a taxable event unless the loan limits and repayment rules are violated, and it has no impact on your .
Assuming you pay back a short-term loan on schedule, it usually will have little effect on your retirement savings progress. In fact, in some cases, it can even have a positive impact. Let’s dig a little deeper to explain why.
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Understand The Limits On How Much You Can Borrow
Just because you have a large balance in your 401 and your plan allows loans doesnt mean you can borrow the whole amount. Loans from a 401 are limited to one-half the vested value of your account or a maximum of $50,000whichever is less. If the vested amount is $10,000 or less, you can borrow up to the vested amount.
For the record, youre always 100 percent vested in the contributions you make to your 401 as well as any earnings on your contributions. Thats your money. For a company match, that may not be the case. Even if your company puts the matching amount in your account each year, that money may vest over time, meaning that it may not be completely yours until youve worked for the company for a certain number of years.
Example: Lets say youve worked for a company for four years and contributed $10,000 a year to your 401. Each year, your company has matched 5% of your contribution for an additional $500 per year. Your 401 balance would be $42,000. However, the companys vesting schedule states that after four years of service, youre only 60% vested. So your vested balance would be $41,200 . This means you could borrow up to 50% of that balance, or $20,600.
Now lets say that after ten years of service, youre fully vested and your balance has grown to $120,000. The maximum you could borrow is $50,000.
The government sets these loan limits, but plans can set stricter limitations, and some may have lower loan maximums. Again, be sure to check your plan policy.