By Mary Spurrier
Approximately 75 percent of all 401(k) plans have loan provisions. In an ideal world, we'd leave our retirement plans alone. Let's face it, life happens and, in an emergency, you may need the money. But taking a loan against your 401(k) may have devastating consequences if you are not careful.
Each plan has its own specific loan features and restrictions. Make sure you check with your plan provider to see what those are. Most plans have a minimum loan and may prevent you from borrowing from the company match. Plans usually have a maximum repayment term of five years. In most cases, your loan payments will be taken directly from your paycheck. Once the loan is issued, you usually can't change the payment terms. The interest rate is often the prime rate plus 1 percent.
There are often charges attached to the loan such as origination and annual maintenance fees. That $1,000 loan could actually cost you $150 in fees, or 15 percent.
If you default on your loan, the amount due is treated as a distribution and taxable as ordinary income. If you are younger than 59½, you will have to pay an additional 10 percent penalty. If you have already spent the money and weren't planning on those taxes, it could lead to big problems on April 15.
There is also opportunity cost. If the stock market goes up, you will miss out on that additional tax-deferred growth. If you leave your job, in most cases, you will have only 60 days to pay the loan back. If you default, your employer will report it to the IRS and it will become a taxable event subject to the 59½ penalty.
There are some strong disadvantages to 401(k) borrowing. The opportunity cost and early withdrawal penalties are arguably the worst. Think very carefully about this loan and use it only as your last resort.
Spurrier is the president of M. Spurrier Financial Services LLC. She can be reached at (585) 271-5280.
This column is written by members of the Rochester Women's Network (rwn.org).