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August 9, 2002/Elul 1 5762, Vol. 54, No. 47
Borrowing from your 401(k)
LEE C. EISINBERG
Special to Jewish News
If you need a substantial sum of money for a new home, or for your child's college tuition, or for any other reason, then you may be tempted to borrow from your 401(k). But, before you do, make sure you know what's involved - a 401(k) loan may be more costly than you think.
Initially, a 401(k) loan can look pretty good. In the first place, it's easy to do - you can borrow up to 50 percent of your vested account balance for any purpose, provided you pay it back within five years. And if you use the money to buy a home, you may have up to 30 years to repay the loan. Furthermore, when you repay the loan, you'll be paying yourself. And yet, there are some definite drawbacks to borrowing from your 401(k). Here are a few to consider:
Quick repayment required upon leaving job If you quit your job, or even if you're laid off, your five-year repayment period may go out the window - in fact, you'll generally have to repay your 401(k) loan within 90 days of leaving your employer. If you miss the deadline, then the loan is considered a withdrawal, which means you will have to pay taxes on the loan balance. And, if you're under 59 1/2, you'll also owe a 10 percent early withdrawal penalty.
After-tax payments Even if you stay with your current employer and you pay back your 401(k) loan, you may not be getting the best use out of your money. Your original 401(k) contributions were made with pre-tax dollars, which lowered your annual taxable income, but your loan payments are made with after-tax dollars, so you don't get any tax advantages - and you're using money that could conceivably be invested more favorably elsewhere.
Less money saved for retirement The more money you borrow from your 401(k), the less you'll have available when you retire. Even though you'll eventually repay the loan, you'll still lose time in which your money could have been compounding. Before you borrow from your 401(k), look for other alternatives. You may be able to restructure your investment portfolio somewhat to provide you with a greater cash flow. Or you may want to look at other types of loans, such as a home equity loan, which can be tax-deductible. (Be aware, however, that you'll be using your home as collateral.) Remember, your 401(k) plan was designed for one purpose only: To help you save money for retirement. So do whatever it takes to keep your plan intact. Years from now, you'll be glad you did.
Eisinberg is a financial consultant at RBC Dain Rauscher in Phoenix. The opinions expressed are those of Eisinberg and do not necessarily reflect those of the firm. RBC Dain Rauscher is a member of the NYSE and SIPC. For further information contact Eisinberg at 602-508-7863 or 888-595-4166.
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