retirement

How do I: Take a loan from my 401(k)?

Topic: Retirement
Who is affected: Consumers at every life stage
DEGREE OF DIFFICULTY: Moderate
What you'll need: 401(K) Plan Terms and Conditions, Documentation of Need

What you need to know

A 401(k) loan is a way to borrow cash from your retirement account, which is then paid back, with interest, through payroll deductions.

The terms of the loan, and whether you're eligible at all, are determined by the rules governing your employer's retirement plan. Some plans allow loans with few strings attached, while some don't allow loans at all. Others only allow borrowing for specific purposes, such as buying a home, paying for funeral expenses or paying for medical expenses. Think long and hard about the pros and cons of these loans before jumping in.

Pros:

  • Less paperwork than most other kinds of loans, and no credit check.
  • The interest rate is usually lower than for other loans -- usually the prime rate plus 1 percent -- and you'll be paying yourself.
  • Credit is unaffected if you default.

Cons:

  • There's usually a limit on what percentage of the 401(k) account's assets you can borrow.
  • You'll be paying interest to yourself, but you may still end up with less money overall because you'll be missing out on market gains.
  • You'll be taxed twice -- once on the after-tax dollars used to pay the loan back, and once when you withdraw the money after age 59½ .
  • If you lose your job, you must pay the loan back quickly, usually within two months.
Step-by-step
Taking out a 401(k) loan is usually pretty simple. Most likely, you'll have to fill out a few short forms specifying how much you want to borrow and which investments you'd like to convert into cash. The loan funds then will be deposited automatically into your bank account.
The only other potential hoop to jump through comes if your 401(k) plan requires specific financial need on your part. In that case, you'll need to provide documentation of your situation before qualifying for a loan.
A 401(k) loan can have far-reaching consequences for your retirement. Before borrowing, ask yourself these three questions from the Bankrate feature, "Need money? You could tap your 401(k) ...":

1.Why do you need a loan?
2.Do you need to spend the money now, or can you wait until you've saved more cash?
3.Is there an alternative?

 

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