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Borrowing Money from Your 401(k) Good idea? ...not so much

7/12/2021

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For years you have put away money from your pay into your employer provided 401(k) retirement savings account. Your employer may have even matched 50% of your contribution. Now you want to take some of this money out in the form of a loan to help pay your bills or to buy a car. Before you take action, here are some things to consider.

Loan versus withdrawal
If you withdraw funds from a 401(k) prior to age 59 ½ you may be in for a surprise at tax time. Withdrawals are subject to income tax and often are subject to a 10% early withdrawal penalty. A better option is to consider loaning yourself the money. 401(k) loans are available for up to 50% of your account balance.

The advantages
There are many advantages of borrowing money from your own retirement account.
No immediate tax. You do not pay income taxes on the funds lent to you. If you withdraw the funds, you must pay ordinary income taxes and a potential penalty on the withdrawal.
You repay the loan. This re-establishes your original retirement account contributions for use during retirement.
Your interest payment is to yourself. Your 401(k) loan payment includes interest. This interest provides you a return on your original contributions. It is better to pay yourself interest than to pay this interest to a bank.

The disadvantages
Repay or else. If you leave your current employer you will need to repay all outstanding 401(k) loans immediately. If you do not, your remaining loan balance turns into a withdrawal subject to income tax and a potential early withdrawal penalty.
Opportunity lost. Your 401(k) loan amount is no longer invested. While your interest payments provide a small return, it usually is much lower than those available through retirement account investment options.
Less take home pay. If you wish to continue contributing to your retirement savings at the same level as before you took out the loan, your take home pay will now be lower as you are making contributions AND paying off your 401(k) loan.
When making the tough decision to borrow your retirement savings, remember to first consider all your alternatives. But most important, understand if you leave your job you must repay the loan or face a potential tax hit!

"Tax Tips" are published to provide current tax information, tax-cutting suggestions, and tax reminders. If you would like more information on anything in "Tax Tips," or if you'd like to be on our mailing list to receive other tax information from time to time, please contact our office.
 
The tax information contained in this site is of a general nature and should not be acted upon in your specific situation without further details and/or professional assistance.
 
We are trusted CPA advisors servicing Burr Ridge, Hinsdale, Willowbrook, Darien, Naperville, and all Chicagoland area. 
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Do you need assistance with your business and/or personal tax returns? Would you like to have a trusted source for your accounting, allowing you additional time to focus on increasing your business? Do you use QuickBooks, or plan to in the future, for your accounting? We include these in all our service packages, customized to fit your personal or business needs.  
 
We are currently accepting new clients. Your initial consultation is free, so you have nothing to lose and everything to gain. Our experienced staff is available to help you streamline your accounting, giving you more free time for yourself. Set up an appointment today by calling (630) 320-3720 or email us at [email protected]. 
 
For more free resources, such as Tax Organizers, and Record Retention Schedules, access our website www.monarchaccountinggroup.com.

Mia Verc, CPA;  Janice Papais, CPA
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145 Tower Drive, Suite 10
Burr Ridge, IL 60527-7836
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  • Home
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