For many consumers a 401k loan can be a viable option to pay off high interest credit card debt, as most 401k plans offer a loan option. When looking for relief from high interest rate credit card debt, consider all of your options before tapping into your retirement funds.
If you have other resources like an equity line of credit or a second mortgage, these might be better suited to provide debt relief. 401k loans do not offer any tax benefits and can come with tax penalties.
Another factor to consider is that you are withdrawing pre-tax funds and paying back the loan with after tax dollars, which will then be taxed again when it is withdrawn at retirement. While the interest rate on the loan may be low, the tax implications add to the overall costs. Payments are generally deducted from each paycheck and must be paid in full over a maximum of 5 years. You will need to reduce your debt enough to cover these weekly, bi-monthly or monthly payments. Also, consider that any withdrawal will remove invested funds and during the payback period, this amount will no longer be growing in value to fund your retirement.
Job security is one of the biggest considerations when deciding to take a 401k loan. If you are laid off or leave your employment for any reason, the loan must be paid back in 60 days. Any outstanding balance after 60 days is considered a distribution. If you are under 59½, this could result in both taxation and a 10% penalty when you file your taxes. The loan amount will be considered income and can significantly impact your tax bill. Failing to make payments on time can also result in the loan being considered a withdrawal and have the same penalties and taxation as leaving your job.
For more information, contact one of our specialists to help you assess if a 401k loan is a good option for you.