Borrowing on 401(k) can be costly

Your Money

March 18, 2007|By Carolyn Bigda | Carolyn Bigda,Tribune Media Services

Most employers — Your 401(k) or 403(b) savings are meant for retirement. But if you're scraping together a down payment for a home or the old car is set to expire, you could borrow from your 401(k) for these short-term needs.

Most employers - 85 percent, according to the Profit Sharing/401k Council of America, a non-profit association of companies and plan participants - allow workers to take a 401(k) loan.

Roughly a quarter of employees who are eligible to borrow from their 401 (k) accounts take out a loan. The main question is whether you should.

The pros

The loans are convenient.

There's no credit check. To apply, you often just have to submit a form online, and the funds are distributed within a week, sometimes in as little as three days, said David Wray, president of the association.

Although you can borrow up to a maximum of 50 percent of your account balance, or $50,000, within a 12-month period, there's typically no restriction on how you use the funds.

The cons

You have to remember that by depleting your 401(k) temporarily, you are missing out on a period in which that money could potentially earn hefty returns. Granted, when you pay interest on a loan from your 401(k) it's deposited in your account, not a bank's coffers. Generally, the rate is based on the prime rate, currently 8.25 percent, plus 1 or 2 percentage points.

That's a sizable rate, and were you to time the withdrawal before a downturn in the market, you could come out ahead.

"If you took out a loan at the beginning of 2000, that worked out very well for you," said Frank Moore, a financial planner in Ann Arbor, Mich. "But you typically don't get that lucky."

In fact, you could remove your money just as the market is poised for a significant upswing.

In 2006, for example, the benchmark Standard & Poor's 500 index had a total return of 15.8 percent.

And although companies make it easy to borrow the cash, the repayment terms can be less accommodating.

You generally have five years to repay the loan (or up to 15 years if the loan is used to purchase a home). But quit your job and, in most cases, you will be given just 60 days to pay off the remaining balance.

Find cash elsewhere

Financial planners often point to traditional sources such as taking out an automobile loan rather than tapping your 401(k).

If you're a homeowner, you also could consider a home-equity line of credit (though, of course, you don't want to borrow too much of your home's value and risk owing the bank when you go to sell).

There's no easy answer. Just remember that in retirement, you'll probably be grateful for every penny in your 401(k).

yourmoney@tribune.com

Carolyn Bigda writes for Tribune Media Services.

Baltimore Sun Articles
|
|
|
Please note the green-lined linked article text has been applied commercially without any involvement from our newsroom editors, reporters or any other editorial staff.