If you have a 401k retirement savings plan at work, it may contain a loan provision. You'll typically be able to borrow up to $50,000 or half your vested account balance, whichever is less, and you'll have five years to repay the money. Borrowing from your 401k can offer a number of advantages as well as disadvantages.
Competitive Interest Rates
An advantage of borrowing from your 401k is that you can typically receive a lower interest rate than if you borrowed from a bank or consumer finance company. You also won't have to worry about paying a higher interest rate if you have poor credit, as credit is not a factor when borrowing from a 401k. As a result, a 401k loan could prove to be a more cost-effective alternative if you need to borrow to purchase a big-ticket item.
Unlike other types of loans, 401k loans are relatively easy to obtain, as you are borrowing your own money and not a lender's. In addition to avoiding a credit check, you won't have to fill out a pile of forms or meet any income guidelines. In most cases, you can arrange for the loan just by contacting your plan's administrator, who can handle the process for you with few hassles. According to the SmartMoney, most companies don't place restrictions on how you use the money.
Although a 401k loan is easy to obtain, there are strict guidelines for repayment. If you do not repay the loan within the five-year time frame and you're under the age of 59 1/2, the amount of your outstanding balance is subject to a 10 percent premature distribution penalty. In addition, the IRS will consider the unpaid balance as taxable income. If you switch jobs before the loan is repaid, you typically must repay the balance within 60 to 90 days, according to Kiplinger.
Another drawback of a 401k loan is that your withdrawn money may not earn as much interest as it would while still in the account, since it is not being invested in stocks, bonds or any of the other funds. As a result, you will have greater difficulty reaching your retirement goals, and you may even have to postpone your planned retirement date. If you withdraw money during a period of high returns, the lost opportunity could have even greater significance.