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The Pros and Cons of Taking Loans in Retirement

The Pros and Cons of Taking Loans in Retirement

There are both pros and cons of taking out a loan and doing this during your retired life is no different. Many of the people take out loans from their 401(k) retirement plans and other retirement plans and find themselves into financial adversities that are quite unprecedented. The pros and cons of taking loans in retirement is a very debated topic and the information given below will definitely help you take a wise decision regarding this.

Pros and cons of taking loans in retirement

Pros

1) Ease of borrowing
Borrowing from your 401(k) retirement plan may be a convenient option for you. There is no need to undergo any credit check or you don’t have to send a loan application to a particular bank. You just need to fill out a simple online form and normally can borrow upto 50% of the vested amount in your account or $50,000, whichever is less. Typically, the repayment term for this amount is fixed at five years. However, if you choose to borrow from your 401(k) retirement plan for buying a home for the first time, the repayment term might be extended.

2) You are repaying yourself
The principal and interest payments that you are making for your loan taken from the 401(k) account are paid to yourself.

3) Affordable interest rate
The rate of interest on a loan taken from your 401(k) account is comparatively less, possibly 1-2 percentage points over the prime rate of lending.

4) Simple repayment
The interest and principal payments for the amount you borrow are normally taken out from your paycheck. As a result of this, the repayment procedure becomes simple and effective.

5) There is no tax or penalty
If you take out money from your 401(k), no tax or penalty will be imposed. On the other hand, if you make a permanent withdrawal, then it is subject to tax irrespective of how old you are and penalty will be levied at 10% if your age is less than 59½ years.

6) The interest income is not subject to taxes
There is no necessity to pay income taxes on the interest that you get on the amount borrowed from your 401(k) account. However, future withdrawals are subject to taxation.

7) No penalty for paying it in advance
You have the option of paying off the whole due amount in advance and it is not subject to any penalty.

Cons

1) Repayment risk
Failure to pay off the amount you borrow from your 401k will attract both state and federal taxes on the outstanding loan amount probably along with a penalty of 10% if your age is lower than 59½ years.

2) Loan remains outstanding if you quit job
If prior to repaying your 401(k) loan, you quit your company, then the entire balance would become outstanding instantly (normally inside a period of two months). Therefore, it is not a wise decision to borrow from your 401(k) if there is a possibility of losing your employment or quitting your job prior to making the repayment of the loan.

3) Repayment with after-tax dollars
The 401(k) loan that you have taken out is constituted by pre-tax dollars which were transferred to your account or made as tax-free income on contributions that you made to the account. However, you have to pay off the loan with after-tax dollars. Therefore, your pretax income has to be more than your borrowed amount to pay off only the principal part.

4) Lost tax-free income
If you take out quick cash online from a 401k, it might not produce tax-free earnings in your retirement account till the time it is paid back to your plan. Therefore, there is a risk of forfeiture of a considerable sum of interest/capital gains/dividends throughout the time for which the loan amount is due. This might impact on the growth of your account because despite the repayment of the amount, the balance would probably be less than it should be.

5) There is no interest deduction
The interest payable on a 401k credit is not tax deductible in spite of the fact that the borrowed amount has been utilized for buying a house.

6) Charges and limitations
Limitations and charges like administrative costs might be imposed on your borrowed amount, subject to the regulations of your employer.

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