401K plan is one of the most popular defined contribution plans in the U.S. The IRS allows 401K assets to be used for certain emergency situations. This plan offers distinct advantages of tax deferrals and borrowing or withdrawing from your own 401K accounts.
401K loans are quite different from other traditional loans as the borrower is borrowing from his own retirement savings. The government ensures that you pay back the amount borrowed from your funds by enforcing certain strict rules and regulations for the loan repayment in time.
The provision of a 401K loan depends upon how the plan has been set up and is not a mandatory requirement. It is advisable for the employees to comply with its strict guidelines so as to evade tax penalties.
The IRC mandates borrowing limits, repayment requirements and the consequences of non-repayment of the borrowed funds. The qualifications for borrowing of 401K loans are mandated by the employer who sets up the loan.
401K loans have unique advantages such as no credit checks as the funds are being borrowed from your own savings and most of the details are not passed on to credit reporting companies. These loans are generally defined with a lower than average interest rates. The interest paid back on a 401K loan is actually for making up the losses on the principal 401K funds.
It is always desirable to have emergency savings fund to cover unplanned financial emergencies 401K account should be the last resort and should not be relied upon at the time of short liquidity crunches. It should be seriously treated as retirement income and not as crisis management funds.
Relying too much on the 401K account may seriously affect the retirement goals and may lead to serious tax consequences and penalties. It becomes important to understand 401K withdrawal and repayment rules. The loan repayment period for a 401 K loan is five years.
However, there may be an extension to loan repayment is when you have borrowed funds to purchase a home. There are many pros and cons of borrowing a 401K loan. This loan may deplete the retirement funds and these pre-retirement withdrawals are taxable.
If the borrower defaults the loan he may be subject to income taxes and 10% excise duty. The borrower is prohibited to contribute to his 401K plan for at least six months after an early distribution. No interest is earned on the investments during the loan repayment.
If the borrower decides to change his employer or if the job gets laid off, he may be asked to repay the entire loan within one month.401K plan administrator should be contacted to know about 401K loan rules and the status of your account for cash sittings that can be borrowed.