Planning for a Loan from 401(k)/403(b) Retirement Account

When you are in need of cash and have no other option to get the required amount, 401(k) and 403(b) plan loans can be the most favorable alternatives.

While contributing to your 401(k) or 403(b) Retirement Plan, you can borrow up to 50% of their deposited account balance or $50,000, whichever is less. But if you have already taken a 401k loan within the past 1 year, then you will be offered an amount obtained by deducting the outstanding loan balance from what you could have otherwise received as loan.

In case you are severe financial distress and you require cash from your 401(k) plan or 403b account, it is better to borrow from the account rather than go for a hardship withdrawal. This is because any such withdrawal from the Plan accounts before the age of 59 and 1/2 years of age requires you to pay a 10% penalty.

Payments against 401(k) or 403(b) loans:
Taking a loan from the retirement account will require you to pay interest at the prime rate plus an additional 1 to 2%. This will allow you to pay back the interest into your plan account so that you can get the money back in the form of disbursements at or near your retirement time. Moreover, you don't have to pay taxes on the interest until retirement when you take out money from the plan account. Either of the loans must be repaid within 5 years of taking it except when it is used for the home financing which may consider payments after a longer term.

Before you decide upon a 401k plan or 403b loan, consider pros and cons of such loans.

• Taking a loan from any of these retirement accounts does not require a thorough checking of your credit history unlike any other loan. You also do not have to make a loan application.
  
  
• The interest rates charged on these loans are comparatively low and can vary according to the plan.
  
  
• You can generate a good deal of return money with your 401k or 403b account. Being a savings account, it provides you with an interest and then there are the interest payments on your loan which are also added to your contribution.
  
  
• Until and unless you retire and withdraw the cash from the account, you will not have to pay tax on the interest payments.
  

The possible consequences of taking a loan from your 401k and 403b Plan accounts:

• When you pay back your loan with interest, you probably take out cash from your savings and checking accounts. This reduces the interest on the cash available in either of those accounts. Moreover, when you are taking a loan from the Plan account, the cash deposited in it reduces and so the interest on the deposited cash also reduces.
  
  
• When you pay off the 401(k) or 403(b) loan from the funds deposited in other accounts, the payments are made with after tax dollars. At retirement, you will have to pay taxes again when you withdraw cash from the plan account.
  
  
• Unless you pay off the loan, it will be taken as an early distribution from the account and you will owe federal and state income taxes along with the 10% penalty provided you are below 59 and 1/2 years of age.
  
  
• If you quit your employment or if you are terminated, then the entire 401(k) or 403(b) loan amount should be paid back within a span of 60 days. But if you fail to pay off the loan, then it will be considered as a default case and you will need to pay the taxes and penalty.
  

401(k) or 403(b) loans are beneficial in the sense that they allow you to borrow cash from your retirement savings but do not charge taxes on the net interest except when you default. There are no such restrictions on the use of these loans except the guidelines put forward by different employers and they also do not require you to have a good credit profile.