While some experts recommend that you should avoid taking advantage of the 401(k) hardship withdrawals options, and exhaust other opportunities such as taking a 401(k) loans instead, it would rather appear that taking 401(k) loans is far worse than the former option.
Before we delve into why 401(k) loans are not any better, let’s check out some of its characteristics below:
- These loans are subject to legal loan limits’;
- They would be repaid through payroll deductions;
- Interest rates are determined by the rules of the 401(k) plan, and the interests will be paid back into your 401(k) plan;
- If you no longer work for a company, where your 401(k) plan resides, you cannot take a loan from there;
- You pay no amount once you take the loan, but be sure to repay on time, as any late payments will result in due taxes and penalties.
I can only identify one advantage of burrowing from your own 401(k) account: money simply moves from one pocket to another, without any real charges incurred since all interests are paid back to your account. So the loan conditions are far better than what you would find in a bank.
So why it is not recommended to borrow from your 401(k) account?
- You end up paying taxes twice. Let me explain. When you pay interest on the loan back to your 401(k) account, the source used to pay is your after-tax salary which has already been taxed. Once you reach retirement and start taking distributions, your interest will be taxed for the second time at withdrawal during retirement.
- The 401(1) is protected from creditors, so taking money from it to pay these creditors is not strategic;
- If you leave your job before the complete payment of the loan you withdrew from your account, the outstanding balance will be treated as a taxable distribution.
In general, hardship withdrawals and 401(k) loans should be avoided altogether because they reduce funds in your account, thereby reducing the amount which can compound over time.
But we live in a reality where unpredictability is part of life. What does this mean? We fall sick, our brothers, sisters, children get married, go to school, etc… It’s life and we need to live with the pace.
So if you find yourself thinking about withdrawing what you have already saved towards retirement, irrespective of the plan you have used, it’s perfectly normal, and you should not feel guilty.
But when you keep going back and withdrawing the little you have saved so far, then opening up a retirement savings account might not be the best way to prepare for that retirement after all. Because it tends out to be more expensive both in the short and long run.
What other better and more effective solutions are available?
You would have to start diversifying your sources of income right now if you don’t want a rather predictable woe to catch up with you during retirement. It’s not late to start checking out other alternatives provided you start checking them now.
CLICK THE BUTTON BELOW:
BACK TO TOP