Jordan Goodman is the author of Everyone's Money Book, available at 888-201-6300. This is the third edition of the book. You can also visit his Web site at www.moneyanswers.com. He talks with us on Thursday mornings.

March 7, 2002

"Borrowing From Your 401k"

Host: You’re probably completely sick and tired of hearing about 401k retirement plans. Well so am I, but we’re going to take a slightly different slant in today’s edition of "The Road to Riches." Personal finance expert Jordan Goodman now on borrowing from your 401k.

Of the many options you have when you need to borrow money to make a major purchase, borrowing against your 401k is one of the more tempting. There are currently hundreds of billions in dollars of loans against 401k balances. Usually, you can borrow up to $50,000 or 50 percent of your 401k balance, whichever is smaller. But it shouldn’t always be the first place to go when you need a quick and cheap loan.

Here are the pros and cons of borrowing against your 401k:

Advantages:

• You can get the loan quickly, usually within a week or so of applying to your company.

• You don’t have to qualify for the loan through a credit approval process because, after all, you’re borrowing your own money.

• The interest rate is quite low, usually at prime rate or slightly over prime, so you would pay about 5 percent to 6 percent today.

• The interest that you do pay is actually paid back to you and your account

• You generally have 5 years to pay it back and usually 10 years if you use it for the down payment on a house

• You avoid any 10 percent early-withdrawal penalties and income taxes that would hit you if you took money out of the 401k

Disadvantages:

• You are slowing down the growth of your retirement fund. The money you withdraw stops growing until you pay it back. Some plans don’t allow you to make more contributions if you have an outstanding loan, which hurts your retirement savings even more.

• You repay the loan through payroll deduction, so the loan will cut down your take-home pay.

• If you leave your job, either voluntarily or involuntarily, you have to repay the entire outstanding balance within 60 days, or face a huge tax bill. This can be very difficult to do when you are leaving your job, particularly if you are laid off. If you don’t pay it back, the remaining balance is hit with a 10 percent early-withdrawal penalty, and you have to pay federal and state income taxes on it that year. So if you had borrowed $50,000 and couldn’t pay it back, you would have to pay a $5,000 penalty, and federal and state taxes that could take another $20,000 of the amount.

But consider this step very carefully before you take it.

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