How do 401(k) loans work?

By Chizoba Morah AAA
A:

When individuals are in a tight spot financially, they usually turn to 401(k) loans. The interest rate for the 401(k) loans are usually a point or two higher than the prime rate, but they can vary. By law, individuals are allowed to borrow the lesser of $50,000, or 50% of the total amount of the 401(k).

Like any other loan, there are pros and cons involved in taking out a 401(k) loan. Some of the advantages include convenience and the recipient of the interest paid. For example, if you take out a 401(k) loan and you are paying 12% interest on it, that 12% is going back to your 401(k) because that is where the money is from. One major disadvantage of a 401(k) loan is the loss of tax sheltered status in the event of a job loss. If you take out a loan on a 401(k) and you lose a job or change jobs before the loan is fully repaid, there is a 90 day period in which the full amount of the loan is to be repaid. If the loan is not fully repaid at the end of the 90 days, not only does the amount become taxable, an additional 10% penalty is charged by the Internal Revenue Service (IRS) if you are under the age of 59.5. (For more on 401(k) plans, read our article: The 4-1-1 on 401(k)s.)

This question was answered by Chizoba Morah

 

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