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Borrowing against the future with a 401(k) loan

Borrowing against the future with a 401(k) loan

Thinking about taking a loan from your 401(k) plan? Think again. It’s no secret that many Americans were hit hard and are still struggling to recover from the financial crisis. Even those who weren’t laid off or downsized during the recent recession may think of their 401(k) accounts as piggy banks instead of the retirement plans that they are. A Wells Fargo analysis released yesterday shows a "28 percent increase in the number of people taking loans out from their 401(k) and that the average new loan balances increased to $7,126 from those taken out in the fourth quarter of 2011 - a 7% increase from $6,662."

Taking a loan from a 401(k) plan can have a devastating impact on a person’s long-term financial – and retirement – security. Though the idea of a 401(k) loan may seem like you’re borrowing money from yourself, it isn’t that simple. Here’s why:

  • Many 401(k) plans prohibit employees from contributing to their 401(k) accounts during the time it takes to repay a loan. Not being able to make additional 401(k) contributions while repaying a loan can significantly affect a person’s ability to add to their retirement nest egg.  
  • 401(k) loans can have enormous tax consequences. If you are unable to repay the loan within five years, the outstanding balance becomes reportable as income, thus increasing your tax liability during a time that may have already seen job loss or other financial setbacks.
  • If you are laid off or switch jobs before you finish repaying the loan, the outstanding loan balance can become due within 60 days of the date you stop working for that employer. If you are unable to repay the loan within that 60-day period, the outstanding balance will be reported to the IRS as income. If you’re under age 59½, you’ll face a 10-percent penalty – bad news, especially for someone who has just been laid off and might already be struggling financially. 

The Pension Rights Center applauds the introduction of a new bill, the Shrinking Emergency Account Losses in 401(k) Savings Act of 2013 or SEAL Act, which would address some of the concerns noted above. The bill would extend the period that workers have to repay their 401(k) loans keep predatory financial institutions from targeting vulnerable workers and retirees with credit cards or debit cards that are tied to 401(k) plans.

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