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If you are in need of a loan, your 401(k) certainly may be an option. But it’s important to understand a bit about them before making your final financing decision.
Note: It is possible to roll this amount into an IRA to avoid taxation. A 2018 tax law change now allows that rollover to occur by the plan participant’s tax filing deadline, including extensions.
Tapping your 401(k) is likely not your only financing option. Here are some others:
Weigh your options
It can be hard to figure out which type of loan makes the most sense. Of course, loans outside of a 401(k) might provide greater variety—different repayment periods, interest-only periods, fixed vs. variable rates, etc. And we’ve discussed the advantages and potential risks above.
Loan-related fees can be substantial, and you’ll want to carefully compare all your options.
When the outside loan rate is below the assumed 401(k) rate of return, the lean is toward going with the “cheaper” outside loan. When the outside finance rates rise above that assumed investment rate of return, the tide shifts to the 401(k) loan, which would then be less costly.
The one big X factor that we mentioned earlier needs to be emphasized again here—returns are not guaranteed; and the more aggressively you are invested, the less guaranteed it becomes, particularly over something like the five-year period.
As you can see, determining whether to go with a 401(k) loan or conventional loan requires some research and planning. Reviewing the decision with a financial advisor may help you make the decision that’s ultimately right for you.
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Updated for tax year 2020
Updated for tax year 2019