Retirement Basics
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retirement
Borrowing from a 401(k)

Admit it: You've pondered the possibility of tapping your 401(k) on at least one occasion.

Why should you wallow in high-interest debt or delay your dream of homeownership, you reason, when your retirement fund spilleth over? It is, after all, your money.

You're hardly alone.

The Employee Benefit Research Institute, or EBRI, and the Investment Company Institute report that 18 percent of all 401(k) participants eligible for loans had borrowed funds from their accounts in 2006.

The average loan amount last year was $8,100, according to Hewitt Associates, a Chicago-based human resources consulting firm.

In some cases, borrowing from your future to finance other goals, including paying for uninsured medical expenses and avoiding financial emergencies, may make sense, says EBRI research fellow Jack VanDerhei.

"There are a large number of situations in which, if one had high rates on credit payments, you would be better off financially to borrow from your 401(k)," he says. "Certainly, avoiding bankruptcy would make it worth your while."

Such loans, however, do carry serious consequences that all retirement savers should consider.

"Employees should think twice before tapping into their 401(k)s," says Pam Hess, director of retirement research for Hewitt Associates. "Employees should be sure they're using the money to meet a need rather than a want because even small loans can seriously diminish their long-term savings."

401(k) loan rules
  • Employee may borrow up to half of their vested account balance to a maximum of $50,000.
  • Most loans must be paid back over a five-year period.
  • If the loan is for the purchase of a primary residence, the term is usually 10 to 15 years.

Advantages of 401(k) loans:

  • 401(k) loans are cheap and easy to obtain.
  • The interest is usually based on the prime rate, plus 1 percent or 2 percent.
  • There are no credit checks, little paperwork and no restrictions on what you are eligible to borrow.
  • Monthly payments are automatically deducted from employee payroll checks.
  • And the best part is (as is often hyped to borrowers) you're paying yourself back with interest.

Hess, however, warns such statements mask the biggest downside to such loans.

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