Whether you’re an employee borrowing from a Barrington 401(k) or borrowing from a small 401(k) in a mom and pop shop, there is much debate about the virtues of loaning yourself some money out of the plan. Sometimes known expenses like college tuition may need an extra cash infusion, or unforeseeable expenses like medical procedures and long-term care can build up quickly over a short period of time and need to be paid.
For situations like these, borrowing from you 401(k) can be an expedient and low-cost way to receive some added income in times of need. However, if you plan on leaving your job or see possible layoffs in the future, you will need to pay back the balance of your loan immediately after you leave the job. Or, as most plans offer, a grace period of 60 or 90 days to arrange plan-loan repayment after leaving work.
If you can’t pay it back, it will be considered a taxable distribution. And If you are under the age of 59 ½, you will also incur an early withdrawal penalty of 10%. However, even if you get hit with the higher rate, not paying back your loan immediately will not affect your credit rating. But you need to pay it back. And if you can set up a short-term payback schedule, you will also have little impact on your overall progress.
That’s because with the payback schedule, you will be paying interest on the loan which you are paying back to yourself. The loan may have no negative impact on your retirement if any lost investment earnings match the “interest” paid in, so if the paid interest exceeds any lost investment earnings, your loan could actually increase your retirement progress.
Another way to avoid negative tax consequences is to find other ways to pay off the loan prior to taking a distribution, because, as mentioned above, there will be repercussions if you are working and you pay the loan back on schedule. There are other times where this type of loan wouldn’t be advisable, such as being close to retirement. Your income stream is slowing down as you invest in more stable and lower return-paying assets as you get near to retirement, so finding an alternative means for additional income is suggested.
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