Make us your home page
Instagram

Might be a good time to borrow from your 401(k)

I recently heard from a family that wondered about taking a loan out of the 401(k) — or maybe a hardship withdrawal.

Did somebody lose a job? Was it hard to pay the mortgage? The car note?

No. The mom told me the son needed braces that would cost about $5,000.

Bad idea? Not necessarily.

Right now, let's consider our economic world where credit card companies are stingy, consumer loans are tight or priced high out of reach, and home values are so low that some families can no longer take out a home-equity line of credit.

I wouldn't recommend taking a 401(k) loan for holiday shopping. But — I cannot imagine I'm saying this — the loan might be reasonable for essentials, such as braces.

Two economists at the Federal Reserve Board in Washington wrote a paper this year that suggests households could save roughly 20 percent — or about $275 per year — of their overall interest costs if they opted to borrow money from their 401(k) plans instead of taking on expensive consumer debt.

The interest rate that many people pay on a 401(k) loan is the prime rate plus 1 percent — or 4.25 percent now — but rates vary.

With the plans at General Motors and Ford, for example, the borrowing rate is the prime rate, 3.25 percent currently.

No credit checks are required, so if you had a bad credit score, you would not pay a higher rate.

While you might think that everyone is rushing to raid the 401(k) in a bad economy, the statistics show otherwise.

Last year, about 18 percent of all 401(k) participants eligible for loans had a loan outstanding against their 401(k) plan, the same percentage for the two previous years, according to a study released this month by the Employee Benefit Research Institute and the Investment Company Institute.

The median loan balance was $3,869 in 2008, down from $4,167 in 2007.

Not all plans offer loans.

Under the law, participants are allowed to borrow up to 50 percent of their vested account balance or up to $50,000 — whichever is less. There is a possible exception if 50 percent of your vested account balance is less than $10,000. In that case, according to the Internal Revenue Service, you'd be able to borrow up to $10,000. However, the IRS notes individual company plans are not required to offer you this exception.

Also, your plan may limit the number of loans you can have outstanding or the amount of time within loans.

Do not ignore the pitfalls of a 401(k) loan.

First, what happens if you lost your job?

If you leave or lose your job, you could have to repay the entire outstanding loan nearly immediately after you leave some companies.

At other companies, you might owe all that money within 90 days to avoid a tax headache.

If you do not meet the deadline in such cases, any unpaid amount will be distributed to you as income, and will then be subject to federal and state income tax. If you are younger than 591/2, you may be hit with a 10 percent early-withdrawal penalty, too.

If you retire or are terminated, you must keep making regular payments to avoid a default.

Second, be warned there can be a huge cost when you stop investing.

If the stock market is miserable, you're fine.

If stocks rebound and show gains of 8 or 10 percent or higher, you're losing out.

Pamela Villarreal, senior analyst for the National Center for Policy Analysis, a free-market think tank in Dallas, noted that taking a $30,000 loan out of a 401(k) plan and paying it back over five years could leave some retirees with $200,000 less at retirement. Use a 401(k) loan calculator at www.retirementreform.ncpa.org.

The Federal Reserve economists — Paul A. Smith and Geng Li — said it's key to make regular 401(k) contributions while repaying the loan.

In general, loans must be repaid within five years. Loans from a 401(k) for the purchase — not refinance — of a principal home may be repaid within 15 years.

Still, should you avoid taking a 401(k) loan? Absolutely.

Might be a good time to borrow from your 401(k) 10/24/09 [Last modified: Saturday, October 24, 2009 4:31am]
Photo reprints | Article reprints

Copyright: For copyright information, please check with the distributor of this item, Detroit Free Press.
    

Join the discussion: Click to view comments, add yours

Loading...
  1. Tampa Club president seeks assessment fee from members

    News

    TAMPA — The president of the Tampa Club said he asked members last month to pay an additional assessment fee to provide "additional revenue." However, Ron Licata said Friday that the downtown business group is not in a dire financial situation.

    Ron Licata, president of the Tampa Club in downtown Tampa. [Tampa Club]
  2. Under Republican health care bill, Florida must make up $7.5 billion

    Markets

    If a Senate bill called the Better Care Reconciliation Act of 2017 becomes law, Florida's government would need to make up about $7.5 billion to maintain its current health care system. The bill, which is one of the Republican Party's long-promised answers to the Affordable Care Act imposes a cap on funding per enrollee …

    Florida would need to cover $7.5 billion to keep its health care program under the Republican-proposed Better Care Reconciliation Act of 2017.  [Times file photo]
  3. Amid U.S. real estate buying binge by foreign investors, Florida remains first choice

    Real Estate

    Foreign investment in U.S. residential real estate recently skyrocketed to a new high with nearly half of all foreign sales happening in Florida, California and Texas.

    A National Association of Realtors annual survey found record volume and activity by foreign buyers of U.S. real estate. Florida had the highest foreign investment activity, followed by California and Texas. [National Association of Realtors]
  4. Trigaux: Tampa Bay health care leaders wary of getting too far ahead in disruptive times

    Business

    Are attempts to repeal Obamacare dead for the foreseeable future? Might the Affordable Care Act (ACA), now in dire limbo, be revived? Will Medicaid coverage for the most in need be gutted? Can Republicans now in charge of the White House, Senate and House ever agree to deliver a substitute health care plan that people …

    Natalia Ricabal of Lutz, 12 years old, joined other pediatric cancer patients in Washington in July to urge Congress to protect Medicaid coverage that helped patients like Ricabal fight cancer. She was diagnosed with Ewing's sarcoma in 2013 and has undergone extensive treatments at BayCare's St. Joseph's Children's Hospital in Tampa. [Courtesy of BayCare]
  5. The Iron Yard coding academy to close in St. Petersburg

    Business

    ST. PETERSBURG — The Iron Yard, a code-writing academy with a location in downtown St. Petersburg, will close for good this summer.

    Instructors (from left) Mark Dewey, Jason Perry, and Gavin Stark greet the audience at The Iron Yard, 260 1st Ave. S, in St. Petersburg during "Demo Day" Friday, Oct. 7, 2016, at The Iron Yard, which is an immersive code school that is part of a trend of trying to address the shortage of programmers.  The academy is closing this summer.  [LARA CERRI   |   Times]