Before you apply for a loan from your 401(k) or 403(B) account you should consider and review the advantages and disadvantages of applying for a loan against your retirement accounts. The following is the advantages versus disadvantes;
Advantages
1) There is not credit history report pulled when you apply for your loan. Credit approval is not a factor in your loan approval.
2) The reason that the credit approval is not a factor is because the funds are already available and in your retirement accounts.
3) Most employer sponsored retirement accounts have no pre payment panalities to pay off your loan early.
4) Your loan payment is deposited directly back into your retirement account to include the interest charged on the loan.
5) If you default on your retirement account loan balance that default does not go against your credit history.
Disadvantages
1) If you defaault on your retirement account that outstanding balance that you owed on the loan will be added to your income for the year that you defaulted on the loan. That could put you in a higher tax bracket.
2) If you are under age 59 1/2 and you have defaulted on the loan you will be subject to the following taxes, 20% federal tax rate, 10% tax penalty and appropriate state taxes.
3) The interest rates on retirement accounts are not fixed interest rates.
4) The loan terms offered are typically 1 to 5 years terms. If you lose your job prior to paying of the loan, you will default on the outstanding balance and that owed balance will count as income during the year that you had defaulted on the loan
5) If you did default on the loan balance you will not be able to apply for another loan.
6) You will receive your loan amount after you sell your mutual fund shares to fund the loan balance. You will be locking in what ever capital gains or losses that occurred in your account. You could be missing out on possible market gains while you are out of the market.
7) Your personal rate of return on your retirement will be negativly affect by your loan withdraw.
As for your employers loan criteria standards, call your hr department for details. In general you can expect to borrower up to 50% our your employee contributions. Most employers do not allow you to borrow against the employer contributed amount.
Some employers only allow an employee only one loan at a time and one loan per years. Other employers have different guide lines. As for your payments to the loan, many employers will automatically withdraw the loan payment from your paycheck. Other, employers require that the payments are directly withdrawn from your bank account.
In this economic climate for today’s economy, you must consider several factors. The Federal Reserve has projected that for 2009, that the unemployment rate will be somewhere around 9% or higher. If you leave on your own or are laid off you will have to either payoff the entire balance of the loan amount, or that remaining balance would be considered income for the tax purposes. I am reminded of the famous Clint Eastwood movie line from Dirty Harry, “Do you feel Lucky?”
As a former retirement service specialist who was let go by his company, I witnessed first hand that devestating impact that this economy has had on the employees across this nation. Over 3.6 million employees have felt the pain and sting of unemployment.
I saw too many employees think of their retirement accounts as another line of credit that they could tap into. Just like homeowners who depleted their equity in their homes by either doing a cash out refinance mortgage or a home equity line of credit. Employee will be facing a serious retirement crisis. The 401(K) retirement systems is in dire need of reform