For years, you have put away money from your pay into your employer-provided 401(k) retirement savings account. Your employer may have even matched 50% of your contributions or contributed 3% of your pay to the account as part of a safe harbor program. Now you want to take some of this money out in the form of a loan to help pay your bills or to buy a car. Before borrowing money from your 401(k), there are some things you must consider.

Borrowing money from your 401(k)

If you withdraw funds from a 401(k) before age 59½, you may be in for a surprise at tax time. Withdrawals are subject to income tax and are often subject to a 10% early withdrawal penalty. A better option is to borrow the money from yourself. 401(k) loans are available for up to 50% of your account balance.

Advantages

There are many advantages of borrowing money from your own retirement account.

• No immediate tax. You do not pay income taxes on the funds lent to you. If you withdraw the funds, you must pay ordinary income taxes and a potential penalty on the withdrawal.
• You repay the loan. This re-establishes your original retirement account contributions for use during retirement.
• Your interest payment is to yourself. Your 401(k) loan payment includes interest. This interest provides you with a return on your original contributions. It is better to pay yourself interest than to pay this interest to a bank.

Disadvantages

• Repay, or else. If you leave your current employer, you will need to repay all outstanding 401(k) loans immediately. If you do not, your remaining loan balance is treated as a withdrawal, subject to income tax and a potential early withdrawal penalty.
• Opportunity lost. Your 401(k) loan amount is no longer invested. While your interest payments provide a small return, they are usually much lower than those available through retirement account investment options.
• Less take-home pay. If you wish to continue contributing to your retirement savings at the same level as before you took out the loan, your take-home pay will now be lower as you are making contributions and paying off your 401(k) loan.

Before deciding to borrow from your retirement savings, consider all your alternatives. But most importantly, understand that if you leave your job, you must repay the loan or face a potential tax hit! Contact our RRBB advisors for more information or if you have any questions.