The Real Cost of 401k Loans - loan

The Real Cost of 401k Loans

One of the strongest concepts in the world of finance is the principle of the time value of money. We won’t bore you with the math, but it basically means that if you put your money in an interest bearing account and leave it alone to compound interest peacefully, you’re going to grow a nice little nest egg. That principle is behind not only savings accounts, but full out retirement accounts.

So why would we even dream about taking money out of these wonderful little accounts? Well, we’re certainly not trying to do it on purpose. This means that the market is actually forcing us to make some pretty tough decisions.  You don’t want to cripple your future, but you can’t get to that future if your present is in danger of fading away. A lot of families have to choose between saving and eating, and that’s a choice that’s pretty painful no matter which way you look at it. So instead of looking at other people critically, you’re going to want to focus on your own financial situation. Let’s say that you’re coming to a point where you really need to get your hands on your 401(k) account for a loan. Is that loan without strings? of course not.

One of the first things that you’re going to have to realize is that if you’re not 59 1/2 or older, there are going to be penalties for a withdrawal. Now, we know what you’re thinking — you’re only taking a loan and not a withdrawal, right? Well, not so fast. You see, if you’re taking from a work based retirement account and you lose your job, that loan can be called immediately. There are cases where you can work out payment arrangements, but far too often loan recipients are being forced to pay the entire loan back in full when they lose their jobs, adding further insult to massive injury. They lost the very thing that they were going to repay the loan with — what a hardship!

Obviously if you can’t pay the loan then there’s going to be some trouble ahead for you. Your loan suddenly becomes a withdrawal instead of a loan — and that’s going to come with some stiff price tags. You see, it’s that 59 1/2 age rule again — if you’re not old enough for distributions, then you’re going to be on the hook for a 10% penalty as well as full taxes on the amount. It’s considered income, and you can’t hide it either — the 401(k) company will report to the IRS before you can even think about covering up the receipt of the funds. There’s just too much of a paper trail, so don’t think that you’re going to do anything different than what other people have done. (It’s just better for your finances if you stay honest — the IRS is nothing to play with!

From here, you’re going to want to look into the rules of your specific retirement plan. Some plans do not let you make contributions if you have an outstanding loan, which means that you’re going to end up falling further and further into the red as your retirement account stops growing. That’s not a good thing at all, especially in a society where today’s elderly aren’t able to work the same hours and intensity patterns that they’re accustomed to from the younger days.  You never know what your future is going to hold, so the concept of being able to just wait around for the job market to get better so that you always have a job isn’t as optimistic as you might think.

When your back is against the wall and you don’t have any other options of credit, the 401(k) loan is definitely the way to go. Just make sure that you’re actually looking at every factor equally and then take action quickly — it can take a few weeks to receive your money, so make sure that you can wait until you get it!

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