Articles - Archived Expert Advice

Borrowing from your 401(k)

I am considering borrowing from my 401(k) to start a small home business on the side to generate extra income. Is this a good idea?

Before tapping into your 401(k), make sure you understand the loan terms, because borrowing rules are strict. Talk to your human resources department to learn the specific rules of borrowing from your employer’s plan. Most plans allow you to borrow up to 50 percent of your vested account balance, or $50,000, whichever is less. Borrowers normally have five years to repay the loan, and employers generally deduct loan payments, including interest, from your paycheck each month.

If you change jobs or get laid off, the loan must be repaid within 60 to 90 days. Otherwise, the IRS will treat the withdrawal like a taxable distribution, subject to income tax and possibly a 10 percent early withdrawal penalty if you are younger than 59½.

One of the biggest disadvantages of taking out a 401(k) loan is the loss of compounded tax-deferred growth of the money you’ve borrowed. You give up all the earnings the borrowed money would have earned had it stayed in the account, plus you run the risk of not being fully invested in the markets when growth opportunities occur. In addition, you will experience a smaller paycheck, as you must repay the loan through payroll deductions.

Bottom line: Exhaust all other options and resources before borrowing from your 401(k). Call or visit one of your Credit Union branches and talk with a loan officer about your situation. You may be eligible for a personal loan, home equity line of credit or other loan program.