Can I Stop Making 401k Loan Payments? Bob Powell, CFP and Co-Founder of finStream.TV interviews Denise Appleby, CEO of Appleby Retirement Consulting Inc., a firm that provides IRA tools and resources for financial and tax professionals. Denise discusses 401k loan payments.
A 401(k) loan is a type of loan that allows an individual to borrow money from their 401(k) retirement savings account. 401(k) loans are offered by many employers as a feature of their retirement plans, allowing participants to access funds for various purposes, such as paying off debt, covering unexpected expenses, or making a large purchase. Here are some key features of 401(k) loans:
- Borrowing Limits: The maximum amount that can be borrowed from a 401(k) plan is typically the lesser of $50,000 or 50% of the vested account balance. However, some plans may have different borrowing limits, so it’s essential to check with the plan administrator for specific details.
- Interest Rates: The interest rate on a 401(k) loan is usually set by the plan administrator and is typically based on the prime rate plus a margin. While interest rates on 401(k) loans are often lower than those on other types of loans, borrowers essentially pay interest to themselves since the interest goes back into their own 401(k) account.
- Repayment Terms: Repayment terms for 401(k) loans vary by plan but typically require the borrower to repay the loan within five years. However, longer repayment periods may be allowed for loans used to purchase a primary residence. Repayments are typically made through payroll deductions, with equal payments made on a regular schedule (e.g., monthly or quarterly).
- Tax Treatment: 401(k) loans are not considered taxable income, so they do not trigger income taxes or early withdrawal penalties if repaid according to the terms of the loan. However, if a borrower fails to repay the loan on time or leaves their job before repaying the loan, the outstanding balance may be treated as a taxable distribution, subject to income taxes and potentially early withdrawal penalties if the borrower is under age 59½.
- Impact on Retirement Savings: Borrowing from a 401(k) can have implications for long-term retirement savings. When funds are borrowed from a 401(k) account, they are no longer invested in the market, potentially missing out on investment gains. Additionally, if the borrower is unable to repay the loan, they may reduce their retirement savings and jeopardize their financial security in retirement.
- Risks and Considerations: While 401(k) loans can provide access to needed funds, they should be used judiciously and as a last resort. Borrowers should carefully consider the potential risks and consequences, including the impact on retirement savings, the cost of interest, and the potential tax implications of default.
Overall, 401(k) loans can be a valuable option for accessing funds in times of financial need, but borrowers should weigh the benefits against the risks and explore alternative sources of funding before taking out a loan against their retirement savings. Additionally, individuals should consult with a financial advisor or tax professional to understand the specific terms and implications of 401(k) loans in their particular situation.
Watch more finStream videos featuring Denise Appleby at this link: https://www.finstream.tv/featured/denise-appleby/