For years you put money from your paycheck into the 401 (k) retirement savings account provided by your employer. Your employer may even have matched 50% of your contribution. Now you want to withdraw some of that money in the form of a loan to help pay your bills or to buy a car. Before taking action, here are a few things to consider.
Loan against withdrawal
If you withdraw funds from a 401 (k) before the age of 59 and a half, you might have a surprise at tax time. Withdrawals are subject to income tax and are often subject to a 10% early withdrawal penalty. A better option is to consider loaning you money. 401 (k) loans are available up to 50% of your account balance.
There are many advantages to borrowing money from your own retirement account.
No immediate tax. You do not pay income tax on funds loaned to you. If you withdraw the funds, you must pay regular income taxes and a potential penalty on the withdrawal.
You repay the loan. This restores your original retirement account contributions for use during retirement.
Your interest payment is yours. Your 401 (k) loan payment includes interest. This interest gives you a return on your initial contributions. It is better to pay yourself interest than to pay that interest to a bank.
Refund or else. If you leave your current employer, you will need to repay all unpaid 401 (k) loans immediately. If you don’t, your loan balance turns into a withdrawal subject to income tax and a possible early withdrawal penalty.
Lost opportunity. Your 401 (k) loan amount is no longer invested. Although your interest payments offer a low return, it is usually much lower than those available through the retirement account investment options.
Less take-home pay. If you want to continue to contribute to your retirement savings at the same level as before you took out the loan, your take-home pay will now be lower as you contribute and pay off your 401 (k) loan.
When making the difficult decision to borrow your retirement savings, remember to consider all of your alternatives first. Most importantly, understand that if you quit your job, you have to pay off the loan or face a potential tax impact.
– By Nancy J. Ekrem, CPA
PC of the DME CPA group
Certified Accountants and Business Consultants