07 June 2016

Thinking About Raiding Your 401(k)? Think Again

Did you know that in companies with more than 500 employees, more than 90 percent of workers participate in a 401(k) plan?¹ And in 95 percent of these plans employers made a matching contribution in the past year.² This is great news. Employees realize they need to take an active role in saving for their retirement, and employers are helping them with matching funds.

But here’s the catch. When employees fall upon hard times, they tend to tap their 401(k) plans. In fact, more than 11 percent have borrowed against their accounts for any number of reasons — from an unforeseen emergency to making ends meet.³

That’s why education and communication is vital in helping employees understand the pros and cons of raiding their 401(k).

Borrowing against a 401(k)

Pros:

  • 401(k) rules permit loans up to 50 percent of your total savings (limited to $50,000).
  • The annual interest rate (APR) is generally prime plus a percentage point or two (so about 3 percent today), which is lower than the APR charged on a credit card advance (now averaging 15 percent) or a payday loan (400 percent and up).

Cons:

  • You may be required to pay a loan origination, administrative, maintenance or other fees — all of which add to the loan’s cost and further drain your account.
  • You need to make regular loan repayments, at least quarterly, until the loan is repaid.
  • The loan repayments are made in after-tax dollars. This means you’re missing out on tax advantages by replacing tax-free savings with after-tax dollars.
  • You need to repay the entire loan within five years or the outstanding balance is considered a “withdrawal,” which means you’ll need to pay applicable taxes and penalties on the “withdrawal” amount.

When communicating the pros and cons to your employees, be sure to update loan rules based on your company’s plan design.

Happy writing!

 

1 Department of Labor
2 Plan Sponsor Council of America
3 Fidelity data analysis