Borrowing Against Your 401K: A Loan From Your Future Self

Thinking about a 401k loan? A 401k is meant to fund retirement, but you can withdraw money from it earlier. There can be negative consequences if you borrow from your 401k but they are not as dire as we have been led to believe. Using the money to make or save money or to pay off high-interest debt can pay off.

 It goes against personal finance philosophy to take money out of a retirement account before retirement, but under the right circumstances, it is something to consider.

401k Recap

By now most of you know what a 401k is but for those new to the site, this will get you up to speed. A 401k is an employer-sponsored retirement account. Employee contributions are deducted directly from your paycheck before they are taxed.

The money is invested into one of the funds offered by the employer. If you’re lucky, your employer matches your contribution. This is free money. For the year 2017, you can contribute up to $18,000.

Because that money is meant for retirement, withdraws are discouraged before you reach age 59 ½. If you withdraw money before that age, you will be hit with a 10% penalty. There are some exceptions.

If you are no longer working at age 55, if you are using the money to pay medical expenses, or if you have become disabled for example, you can withdraw the money penalty-free.

Another way to access that money without the penalty is the subject of this podcast. You can borrow money against your 401k without being penalized.

FYI: If picking funds in your 401k, 403b or TSP gives you anxiety, or you fear you’ve made terrible choices than you need Blooom. You’re welcome.

Why a take a 401k loan?

There are lots of good reasons to invest in a 401k. Not many people get a pension anymore so a 401k may be their only retirement plan. There is also a low bar to invest in a 401k. Your employer does the work; you just have to opt-in. You don’t have to know anything about investing to get started.

Contributions are taken directly from your paycheck, so you never have a chance to spend the money. For some people, this is the only way they will save for retirement.

The money goes in and grows tax-free. This can help reduce your taxable income and bump you down to a lower tax bracket. When you retire and need the money, most of us will be in a lower tax bracket than we were during our working years, so that is a tax saving. A 401k can also be a great place to borrow money from.

How it works

Borrowing against your 401K means, you are borrowing from yourself. Unlike borrowing from a bank, the interest you pay, you pay to yourself. The amount you borrowed is no longer invested so rather than getting investment gains; your “gain” is the interest you pay back.

You can borrow up to $50,000 if you have a vested balance of at least $100,000 or 50% of the value, whichever is less.

You indicate the account you want to borrow money from. Those investments will be liquidated. You will lose any gains those investments might make during for the duration of the loan. Depending on the plan rules, you may or may not be allowed to continue making pre-tax contributions.

You have five years to pay back a 401k loan, then if the loan was used to buy a home that will be used as your primary residence. There is no early repayment penalty. Most plans allow you to repay the loan through payroll deductions, the same way you invested the money.

Good Reasons to Borrow Against a 401k

If you need money fast and for a short period, a year or less, borrowing from your 401k can be a good solution. You’ll have the money quickly sometimes within a few...

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