401k Plan
Loans
Allowing loans within a 401k plan is allowed by
law, but an employer is not required to do so.
Many small business just can't afford the high
cost of adding this feature to their plan. Even
so, loans are a feature of most 401k plans. If
offered, an employer must adhere to some very
strict and detailed guidelines on making and
administering them.
The statutes governing plan loans place no
specific restrictions on what the need or use
will be for loans, except that the loans must be
reasonably available to all participants. But an
employer can restrict the reasons for loans.
Many only allow them for the following reasons:
(1) to pay education expenses for yourself,
spouse, or child; (2) to prevent eviction from
your home; (3) to pay un-reimbursed medical
expenses; or (4) to buy a first-time residence.
The loan must be paid back over five years,
although this can be extended for a home
purchase.
Usually the participant is allowed to borrow up
to 50% of their vested account balance to a
maximum of $50,000 (set by law). Because of the
cost, many plans will also set a minimum amount
and restrict the number of loans any participant
may have outstanding at any one time.
Loan payments are generally be deducted from
payroll checks and, if the participant is
married, they may need their spouse's to consent
to the loan.
Funds obtains from a loan are not subject to
income tax or the 10% early withdrawal penalty.
If the participant should terminate employment,
often any unpaid loan will be distributed to
them as income. The amount will then be subject
to income tax and may also be subject to 10%
withdrawal penalty. A loan can't be rollover
into an IRA.
There are generally four reasons given to avoid
401k loans if possible:
* Lower investment return. According to the
General Accounting Office, the interest rate you
pay yourself on your plan loan is often less
than the rate your plan funds would have
otherwise earned, and you lose the benefits of
compound interest.
* Smaller contributions. Because you now have a
loan payment, you may be tempted to reduce the
amount you are contributing to the plan and thus
reduce your long-term balance.
* If you quit working or change jobs, you must
pay back the loan right away. It's not uncommon
for plans to require full repayment of a loan
within 60 days of termination of employment. If
you don't repay, the loan is considered
defaulted, and you are taxed on the outstanding
balance, including excise taxes in many cases.
* Repayment of principal and interest is made
with after-tax dollars. By contrast, a home
equity loan from a bank is often structured so
that the interest you pay is tax-deductible. On
a larger loan, this could add up to significant
savings.
Go to www.401khelpcenter.com for more
information on this and other 401k issues.
This article is the property of
www.1st-in-homeloans.com, which has been
offering home mortgage services since 2002. To
find out more visit
www.1st-in-homeloans.com
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