It’s your money, so can you or should you, borrow from you 401k?

Next to owning a home, your 401k may be your greatest asset… and yes, you can borrow from it to make a down payment on a new home.

How it Works

Most 401k’s (check with your plan administrator) will allow you to borrow up to 50% or $50,000 of the account value, whichever is lower.

Usually the interest rate you pay is the prime rate, which at this time is 3.25%.

The term is usually 15 years for a home purchase. When you’re borrowing money for personal use, the term is usually 5 years.

There are three advantages to borrowing from your 401k:

1. The rate you get is usually pretty cheap.

2. The money you borrow is not taxable.

3. The interest due on the loan is paid back into your 401k account.

However, there are serious drawbacks to borrowing from your 401k:

1. If you quit your job or you are fired, your employer can no longer take the loan payment out of your paycheck, so the loan becomes due and payable.

2. If you have to cash in your 401k to satisfy the loan,you will be liable for tax and penalties.

3. Although you can rollover your 401k to a new employer, your tax penalties cannot be rolled over.

4. You lose some of the growth in your account. It’s likely that to afford to pay back your loan you will have to cut back on your withholding’s. So rather than putting more money into your 401k, (buying more share), you are paying back your loan.

5. You are losing compound interest that you could be earning on that money.

6. You are paying back your account with after-tax money, rather than paying into your 401k with pre-tax money.

Another Option

You can liquidate up to $10,000 as a first time buyer. Under a 401k plan, this is considered a hardship withdrawal.  However, you will be penalized a 10% tax in addition to your regular income taxes. There may be other penalties also.

For more details contact us and a qualified tax advisor.