401K: Taking a 401K Loan

Millions of Americans have 401k plans through their place of employment, making monthly 401k contributions to save for retirement. Taking out a loan from the money in your 401k plan is possible but doing so can be costly if you don’t pay back the loan in time.

When you borrow money from your account, the transaction isn’t treated as a 401K withdrawal, its treated as a 401k loan so you don’t have to pay taxes or any early withdrawal penalty of 10 percent. When you take out a loan, you have to pay the money back in five years with interest. You earn the interest you are paying so that is a good deal for you.

On the other hand, if you borrow money from your 401k and don’t pay it back in five years you will have to pay taxes on the money withdrawn and a 10 percent penalty. Another thing to consider is you are paying back the 401k loan with after tax money, while the money you withdrew was saved with before tax money.

If you’re not in need of a loan right now you should start an emergency fund and put away a certain percentage of your income each month into a savings account until you have about six months of expenses saved up. Saving six months of expenses will probably take some time so start right away. The best time to start saving was yesterday, the second best time is right now!