Think before you borrow from your 401(k)

[Common Sense Party]

You may compromise your retirement.

One of the biggest advantages of a 401(k) is that all deposits occur before they’re counted as income. Moreover, all invested funds grow tax-free. Loans can cut into that crucial growth. “Since so many Americans are woefully prepared for retirement in the first place, the tradeoffs can be significant,” says financial planner Stuart Armstrong of Centinel Financial Group in Needham Heights, Mass.

Repayment may be tight.

You have five years to repay what you borrowed if you stay in your job. But if you leave your job, the time frame is just 60 days.

If you can't pay, taxes and penalties kick in.

The penalty for early distribution is 10%, and “depending on the federal tax bracket and state taxes due as well as the penalty, the total amount could be a sacrifice of up to 40% to 50% of the gross withdrawal,” Armstrong says.



more: http://www.usaweekend.com/article/20111209/MONEY/312090010/Think-before-you-borrow-from-your-401-k-?odyssey=tab%7Ctopnews%7Ctext%7CFrontpage

[Common Sense Party]

1. The other downside can be paying taxes twice.

Think about this:

Let's say you've contributed $10,000 pre-tax to your 401(k) over the years. Now you take out a loan and borrow $5000 of that pre-tax money.

You pay back the loan over the next five years. But you have to pay it back through payroll deductions, and those deductions are made AFTER taxes. So, while you borrowed PRE-tax money, you have to pay it back with AFTER-tax money.

So, you pay back the $5,000 (plus interest). Then you get to retirement and you withdraw that $5000 again for your retirement income. What does the government do? They get to tax you again. They double dip you--and they can get away with it, because they're the government.

So don't borrow from your 401(k) unless you absolutely have to.

[msedano]

2. how about the interest on the payback?

the interest pays into the account holder's own funds. so a loan at 15% interest increases your own holdings by that interest, no? that's the way my 401k loan program functioned when i was a worker.

mvs

[Common Sense Party]

3. Yes, you're paying the interest back to your own account

Thankfully the interest rates aren't anywhere close to 15% (closer to 4 or 5% now, I'd guess...usually Prime or a point or two above).

The biggest "risk" about taking out the loan is IF (and it's a big if) the markets make a big move upwards, the money you've borrowed out won't participate in the upswing.

Of course, in 2008, a loan was the best place to have had your money.