A 401(k) loan can sound like a
great option to pay off credit card or other debts. But there are significant
factors to consider before doing this.
Taking
a 401(k) loan can seem attractive for a few reasons: You don't have to qualify.
You can get the funds quite quickly. Plus the interest rate you pay back to yourself
is typically around 4% to 5%, far below the typical credit card interest rate.
If
your plan allows loans you are typically allowed borrow 50% of your balance up
to $50,000, which you then must pay back (plus interest) through automatic
payroll deductions. Typically, the loan must be repaid within five years.
Nearly
half of all retirement savers who had taken a 401(k) loan said they had
borrowed the cash to pay down debt, according to a recent survey from
retirement provider TIAA-CREF.
But
there are a lot of things that can go wrong.
Not
only are you depleting your current retirement savings, but you will also miss
out on the compound returns those funds would have gained over time.
And
you will be paying the loan back with after-tax dollars and then pay taxes
again when you withdraw the savings in retirement. This double tax hit can be
signiicant.
And
if you lose your job or switch to a new one, the timeframe to pay back the loan
shrinks to as little as 60 days. If you're unable to repay it by that deadline,
you could be hit with another tax bill and a 10% early withdrawal penalty if
you're younger than 59 1/2.
If
you're still thinking of taking a loan to tackle debt, here are some things to
consider.
What
kind of debt is it? The only kind
of debt you should even consider raiding your nest egg to pay down is extremely
costly debt, such as high-interest credit card bills or a payday loan. That
means that you wouldn't want to use retirement savings to pay down loans with
lower interest rates and longer time spans, such as student loans or mortgage
debt.
Do
you have other options? A 401(k)
loan should be a "loan of last resort." For example, if you have a
good credit score, you might be able to pay down higher-interest credit card
debt with a personal loan from a bank or credit union.
Or if
you think you'll be able to tackle the debt in the next year, consider taking
advantage of a 0% balance transfer offer to transfer the debt to a different
credit card and pay it off without any additional interest payments.
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here for the original article from CNN Money.