For most Americans, a 401(k) is more than just an employer-sponsored plan. It is an ideal way of saving and keeping a contingency option open when required. So, while retirement savings is the primary function, there are some basics of 401(k) loans that you should know about in case you face an emergency, like personal bankruptcy. Here’s what you should know:
- Your loan is repaid through deductions in your payroll
Depending on the amount you borrow from your 401(k) and the interest rate applicable, you would need to repay the loan in equal installments through your monthly payrolls. So, ensure that you are aware of the repayment schedule and how much you earn monthly so that you do not default on repayments.
- You end up paying interest to yourself
The interest rate levied on your 401(k) is based on the plan you are invested in, and it is calculated with a simple formula of “prime rate+1%” to derive the amount. However, this interest is paid into your account itself, so you end up paying yourself.
- An old 401(k) plan is off-limits for a loan
One of the most forgotten 401(k) loan basics is that if you had an old 401(k), borrowing from it is not possible. So, if you have changed jobs, you would need to shift your old 401(k) to the new one, and you can only take a loan if your new employer allows it. However, if you shift your plan to an IRA, you cannot borrow from it.
Checklist before you borrow
To make things easier for you, we have curated a simple checklist that can help you before borrowing money. Here are the top 401(k) loan basics that you should be acquainted with before you consider making a withdrawal:
- Check how much you can borrow. Also, each plan has different eligibility, so ensure that you are aware of how much cover you can expect for a rainy day.
- You would need to understand how the process works in-depth. This includes knowing about the processing fee, minimum loan allowance, taxable proceeds, repayment schedule, and the like.
- Make a rough plan of repayment before you go ahead. So, ask your HR manager or finance expert in your company and work out a plan that lets you know how much will be deducted from your payroll. You can also identify areas where you can limit expenses to avoid going further into debt.
- Think about your career plans carefully and evaluate all your options sensibly as switching jobs could interrupt your repayment schedule.
- Recognize the long-term risks because the future growth of your retirement corpus can be adversely affected by this.
Once you have carefully evaluated everything mentioned here, you can consider withdrawing from your 401(k) loan account. We highly recommend that you consider all your options before settling for this particular one.