401(k) plan is the retirement plan for the benefit of the employees to support them financially in their retirement period. Borrowing against this plan is suggested only if all other resources are exhausted. The pros and cons should be studied clearly before applying to borrow against 401(k) plan. It is a retirement plan which meets the requirements of Internal Revenue Code Section 401(a) and ERISA, the Employee Retirement Income Security Act of 1974. Since the plan is a tax qualified one and is highly beneficial, it is not recommended by the financial advisors to borrow agains this scheme. A portion of the salary of the employee who has registered with the plan is secured and not paid until retirement. The amount thus secured comes under lower income tax ceiling.
Features of 401(k) plan
The program is initiated by the employers to support the employees. The employers make either a matching or an amount either more or less to the 401(k) plan. Some of the employers make it more beneficial by adding profit sharing feature to the program. The employers are at will to deduct the amount they contribute to the plan before the taxes are calculated. All the contributions and the earnings get accumulated on the basis of tax deferment till the amount is withdrawn. It is not recommended to withdraw the deferrals until the participant is 591/2 years of age as there is penalty incurred in doing so.
The amount can be withdrawn in case the employee dies or has financial hardships or if he becomes disabled and not able to work any more. The amount can be withdrawn in case of termination of the plan. Whether it is possible to withdraw against the plan can be understood through the plan documents. In most of the plans, the borrower is allowed to get a loan of around half of the balance in the account. However, the maximum amount of funds that can be withdrawn is specified. The amount borrowed is to be settled in five years. If the purpose of the loan is to purchase the primary residence, the repayment period gets extended and it ranges from 10 to 30 years.
The loan is helpful to the people who need funds to make down payment for the purchase of the house. The repayment is easy as the amount to be repaid is deducted from the employee’s paycheck directly by the company. It is similar to borrowing from oneself. The interest rates are lower and there is no credit check for approval. Borrowing against this plan seems to be impressive. However, there are certain disadvantages which should not be overlooked.
It should be remembered that the plan is to support leading a comfortable retirement life. The interest on the amount borrowed is the loss for the borrower. The borrowed amount is settled with tax. The borrower loses the benefits associated with the plan. If the employer is not able to return the money, the loan becomes a premature distribution. To avoid losing the benefits in the plan, borrowing against 401(k) should be considered only if the borrower has no other means of raising funds.
When you decide to buy property by means of loan against this plan, it should be ensured that the value of the property is sure to appreciate in which case the borrowing is justified. However, you can try other means as well. It is not considered a wise option as you have to bear the tax burden unnecessarily and you are also levied penalties for early withdrawal besides losing interest on the amount withdrawn. If you lose the job, you are required to repay teh loan amount in a period of 60 days which might become stressful for you. You can consult your financial advisors who can guide you regarding this as there are so many sources of funds for the first time home buyers.