A 401(k) is a retirement account sponsored by the company you are working in. it is usually offered by private-sector employees. A traditional 401(k) allows employees to contribute pre-tax dollars from their paycheck to the account and take a tax deduction for their contributions.
A loan from your 401k plan has its pros.
The pros include a no application submission, so you do not need any loan application to fill out or any extra documents. After you have taken the loan it will be repaid automatically by deductions from your paychecks over a period of time. This reduces the stress of paying back the loan as you don’t have to plan how and when to process payment on a regular basis.
Paying debts using 401k plan:
Paying your debt with this plan might only work out in some cases, compared to other ways to pay them off. By taking this loan you are endangering your retirement plans, so be very careful and think before taking a loan from your 401K plan.
If you withdraw money early, you will have to pay extra taxes and penalties which is of course different from loaning the money and paying it back. Ordinarily, this penalty is 10%. For example, if you have to withdraw $40,000 from your account early, you will have to pay $4000 as a penalty. After that, you also have to pay additional federal income tax on this withdrawal. 59 and ½ is the age at which you can start taking distribution from your account without penalties. There are some exceptional cases where you can receive distribution without meeting the age requirement and without being penalized. Some of these cases include but not limited to some home repairs, buying a home, medical bills, school expenses and funeral expenses.
If you leave your employer before repaying the 401k loan, the outstanding balance is treated as distribution with taxes on it, unless all loan is repaid in a specified time be aware of what your taxes should be and pay them. (please see a CPA if you have questions about your taxes).
401k money is protected, it cannot be liquidated in a bankruptcy. If you borrow this money and spend it on debt repayment and you are still in financial deficit and are bankrupted, your 41k money would have been protected from bankruptcy even though you used it to repay debts.
Until you have repaid the loan your employer may not add new contributions to the plan if their contribution is contingent on you contributing to your own account, and that is because all the money being repaid is not considered contribution. That means that while you’re paying back what you’ve borrowed, you’re not adding more to your account.
If you have a large balance to start with, taking a loan from your 401k plan might not make a huge difference in the long run. If you’re already behind on saving, then taking money from your 401k could create a big gap with your retirement planning.
A financial advisor can help you make strategies for both taking a loan and how to repay debts with it. A CPA can discuss the possible tax implications if you decide to take early distribution from your 401K plan. You can find a financial advisor locally and even online using many different platforms.