Most organizations offer incredible options to their employees for saving up for their retirement days, and one of the best ways is to invest in the 401(k) plans. However, aside from being a source of retirement benefits, if there are instances of an immediate financial crunch, you have to look no further. The 401(k) loans are an incredible way of sorting your short-term financial problem too. The interest rate is nominal and your deductions will be made directly from your paycheck. However, like every other form of “loan”, even the 401(k) loan has certain drawbacks.
So, before you arrive at a decision, acquaint yourself with the pros and cons of applying for a 401(k) loan as this might help you make a wise choice.
Pros of opting for 401(k) loan
- Convenient and less time consuming: One of the major reasons why people opt for 401(k) loans is that they are less time consuming and quite convenient. You don’t have to fill out lengthy forms or credit checks. Also, borrowing from your 401(K) plans is extremely easy as these loan requests do not generate an inquiry against your credit or affect your credit score in any way. With a few clicks on the website, your 401(k) loan request will be approved and within a few days, you will have the check in your hands. This process is completely confidential and doesn’t divulge the borrower’s personal details.
- Cost advantage: Other than the modest loan origination or administration fees, there’s no additional cost levied on you for tapping into your 401(k) reserves. All you have to do is specify the investment account from which you wish to borrow the money and those investments will be liquidated for the entire duration of the loan. Though you might lose some positive earnings that could have been generated by these investments for a short period of time, you will avoid any investment losses on this money at the same time.
- You pay interest to yourself: Your loan repayments to the 401(k) account you borrowed from, are usually allocated back into your portfolio investments. Moreover, you will be repaying more than what you borrowed to your account, which implies that you will be paying yourself the interest. This means that the 401(k) loan does not produce any impact on your retirement if any of the lost investment earnings match the interest paid by you.
Cons of opting for 401(k) loan
- You won’t be allowed to make contributions: 401(K) plans might be the perfect place to apply for a loan, but there are certain 401(k) plans that do not let you contribute to your account until the loan is completely paid off. Moreover, this restriction on contributing to your 401(k) plan hits you hard in two areas: contributions and tax advantages. Usually, you can only contribute $18, 500 to your 401(k) plan ($24,000 for people above 50). So, if the particular 401(k) plan doesn’t allow you to contribute to the plan when you have an outstanding loan, you will be losing out on the employer’s contribution as well. So, if you combine this amount with missing out on a match from the employer, it renders a double blow of missed savings.
- Paychecks become smaller: Usually, 401(k) loan repayments are initiated through paycheck deductions. This implies that your post-tax dollars are repaying the pre-tax money you saved, and this makes it more expensive. Also, these deductions will lead to a lower monthly income which isn’t conducive to the idea of comfortable living.
- You will still have to pay fees: Though 401(k) loan appears alluring owing to its low-interest rates, you will still have to bear the brunt of charge setup fees, annual administration costs and more. Moreover, the origination fees usually start at $75 and increase, depending on the provider.