The Risks of borrowing money from 401K Plan

Money is the motivation for a variety of actions. It is not uncommon for an individual to not completely weigh the advantages and disadvantages of taking action in regards to earning, borrowing and spending money. One action that people in a financial crisis have decided to take during times of hardship is to borrow money from 401k. While this may seem like a good idea for a short-term, there are many risks and reasons to find an alternative solution to borrowing money from 401K.


Borrowing money from 401k

A 401K plan is established to support you financially after you retire from your primary occupation. Many people forget about their financial future when faced with an urgent problem that needs immediate action. The solution to this for approximately 15 million individuals is to borrow money from 401k retirement plan. On the surface it seems like the perfect solution because it is convenient, but you don’t need to file any long applications or risk being turned down due to credit or financing limitations. The interest rates that you do have to pay to borrow the funds goes back into your 401k account, which means you are essentially not paying any at all.   

Loan Repayment

One of the primary downfalls of borrowing money from 401k is that if you lose your job for any reason you must pay back the loan within a very short time period of 60 days. If you are unable to repay the full amount of the loan in that time frame it goes into default. This poses a serious problem since it is possible for a loan to end up in a default status as a result of unemployment.

Tax Penalties

If you do default on a 401k loan you not only have less money to use when you retire, but the IRS views the distribution as income and will require that you pay taxes on the amount that was borrowed. This may cause you to pay additional taxes on your regular income as well if you are bumped into a higher tax bracket. Unless you meet the age requirement that is established and mandated on your 401k plan, you will be subjected to paying taxes on the funds when it comes time to file your taxes for the year.

Insurance

If you weigh the pros and cons and still determine that your best financial move would be to borrow money from 401k, there is a way to protect yourself from the potential risks. This protection would come in the form of credit insurance offered by employers that would be responsible for paying the loan if an event such as unemployment or disability occurs. It is currently a way for borrowers to protect themselves with other types of loans, but has not been extended to 401k loan.  The primary concern with insurance for 401k loan is how much companies should charge to offer the service to borrowers. Many borrowers that are struggling financially enough to borrow money from their best retirement funds may be hesitant to purchase the insurance necessary to protect themselves.

Borrowers should keep the risks in mind when deciding to tap into their treasured best retirement funds. Borrowing money from 401k plan may not be as appealing as it originally appeared.

Byline

This article was written by Karl Stockton. He believes it is better to take cash advance from somewhere else than the 401k plan.