Debt Management Basics
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Tapping your retirement account

If you've found yourself in a tight spot and need some money quickly, your 401(k) can provide some relief. But this is a loan with many drawbacks and one that many experts believe should be considered only as a last resort.

Before borrowing from a 401(k), consider these questions:

  • Will you be able to make your loan payment and still contribute to your 401(k) account?
  • Could your credit card spending be curbed?
  • Is your job secure?
  • Can the loan be paid off on short notice if your job is lost? Are the risks of taxes and the early withdrawal penalty acceptable?
  • Are there other ways of getting out of debt? Is it possible to increase monthly payments or get a lower rate for your current loan or credit card? What about cashing in a mutual fund or a savings account?

If you still think your 401(k) is your best option after answering these questions, proceed carefully.

How to tap your 401(k)

Speak with your company's 401(k) administrator -- this person probably works in the accounting or human resources department -- to get the specifics on your plan. Or, you can try calling your plan's toll-free number. Some administrators will quiz you on your need for this loan, but usually they leave it up to your good judgment. Carefully explore all the costs involved and the consequences.

Borrowing from your 401(k) has some advantages:

  • You pay yourself back at a low interest rate, typically 1 percent or 2 percent above prime.
  • Unlike a mortgage, which has recording costs, the transaction costs of borrowing from your plan are generally minimal.
  • There's no credit check.
  • Repaying the loan through payroll deductions is fairly painless.

You pay yourself back at a low interest rate, typically 1 percent or 2 percent above prime. Unlike a mortgage, which has recording costs, the transaction costs of borrowing from your plan are generally minimal. Plus, there's no credit check. Repaying the loan through payroll deductions is fairly painless.

In most 401(k) plans, you can borrow up to 50 percent of your vested balance, but not more than $50,000. You have to pay the money back with interest over five years (longer if the loan is for a principal residence).

 

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