A 401k Loan? Don't Even Think About It!

A 401k loan is not an option if you are serious about your retirement planning and provision.

Tapping into your 401k early is actually easy. There's very little paperwork required. No credit check is required and you need not motivate the reason for the loan. Granted, during a crisis it might be your cheapest and quickest way to get funds, but it may have devastating consequences in the longer term.

Borrowing against your 401k plan is no different from borrowing from any retirement provision plan. However, it puts invisible brakes on your provision plan and may seriously bite you in the back when you approach retirement.

Every retirement provision plan sets it's specific loan benefits and restrictions:

  • Most plans would allow you to borrow up to 50% of your vested balance to a maximum of $50,000. You won't be able to borrow against the cumulative balance of your employer's contribution.
  • There would be a substantial minimum amount set for the loan to discourage the taking of small loans frequently.
  • The maximum repayment period for personal loans is five years.
  • You'll have to repay the loan in equal installments deducted directly from your paycheck until the loan is repaid. It would leave you with less spending money.
  • The interest rate would be set at the time you enter the loan agreement and would normally be at prime plus one.
  • Loan processing fees may be in force.
  • If you leave your job, either by choice or through a layoff, you must repay the loan immediately - usually within 60 days - or face penalties.

If you stop making contributions to your 401k plan while you repay your 401k loan, you'll be creating an even bigger hole in your retirement savings. Some 401k plans have a rule that you can’t contribute to your 401k until you've completely repaid the loan. So, you would be missing out on the opportunity to increase your retirement savings. If your employer matches contributions, that’s even more money you won’t have when you retire.

Asset leakage is the learned term used for the long term financial loss suffered when you loan against your retirement provision plan. It is in your best interest to avoid this subtle leakage.

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