March 06, 2012 09:00 AM
By Jonathan Clements, Director of Financial Education, Citi Personal Wealth Management
Your 401(k) plan is supposed to help pay for retirement. But should you also use it to cover financial emergencies, foot the kids' tuition bills and pay for home improvements?
It's certainly tempting. Many 401(k) plans have loan provisions and borrowing is fairly easy. Since your account serves as collateral, you don't have to go through a credit check and you'll often receive the money within a few days.
You can borrow up to $50,000 or half your account balance, whichever is less. You typically have five years to pay back the money, though the repayment period can be longer if the loan is used for the down payment on a primary residence.
You will owe interest on the loan. But the interest you pay is added to your account balance, which can seem appealing. The interest rate is set by the plan, but it has to be close to current market rates. Loans are generally repaid through payroll deduction.
Put it all together and 401(k) loans can seem pretty attractive. But keep in mind that there's a steep potential cost: The money borrowed comes out of your account. That means there's a potential opportunity cost, because you will miss out on any investment gains the money might have earned.
Moreover, if you leave your employer, you typically have to repay any 401(k) loans right away. Can't come up with the cash? You will likely get hit with income taxes and tax penalties on the money borrowed.
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The information provided is solely for informational purposes. It is not an offer to buy or sell any of the securities, insurance products, investments, or other products named.
Borrowing may not be suitable for everyone.
There is no guarantee that these strategies will succeed and may not be appropriate for everyone. Individual clients should review with their advisor the terms and conditions and risks involved with specific products or services.
Citigroup Inc. and its affiliates do not provide tax or legal advice.
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