Borrowing from a 401(k) account may be smart if the account holder has no alternative, a secure job, a valid reason and the means to repay it on time, states Bankrate. Drawbacks include loss of investment return and a possible tax penalty for late repayment, according to Nolo.
401(k) loans are limited to the lesser of $50,000 or 50 percent of the vested account balance as of 2015, although up to $10,000 is permitted even if the total account is less than $20,000, reports the IRS. No credit check is required, and application fees are nonexistent or minimal, as reported by About.com. Normally, 401(k) loans must be paid back within 5 years, although the payment period is longer when buying a home. Along with the regular payments, which usually begin with the next pay period, the account holder pays back regular interest into the account.
Account holders contemplating 401(k) loans should first consider alternatives, such as refinancing or arrangements with creditors, says Bankrate. Only those with stable jobs should consider them, because if the borrower changes jobs or is laid off, 401(k) loans usually need to be paid back within 60 days. If they are not, they risk being reclassified as regular 401(k) distributions subject to 10 percent penalty tax by the IRS. Buying a home, starting a business or pursuing further education are possible motivations for obtaining 401(k) loans. They should not be used to pay off credit card debt, warns USA Today.