According to a recent Gallup poll, 89 percent of Americans are participating in a 401(k) plan if it is offered by their employer. Among those participating, 96 percent say they are actively contributing to their plan. Plus, according to investment management specialists at Vanguard, by the end of 2013, the average 401(k) account had doubled in size from 2008 levels to more than $100,000.
That’s all great news. It shows that Americans realize they need to take an active role in saving for their retirement.
But here’s the catch. When American workers come upon hard times, they tend to tap their 401(k) plans. In fact, the Gallup data shows that 16 percent have taken out loans against their accounts, 9 percent have made early withdrawals and 5 percent have done both.
A loan is preferable to a 401(k)withdrawal, which is subject to both income tax and a 10 percent penalty if the employee is age 59-1/2. However, based on those stats, it’s important to educate your employees about the pros and cons of taking a loan against their 401(k). The following may help you to craft an article for your next newsletter.
Note: Be sure to update the specific loan rules below, based on your company’s plan design.
Taking a loan against a 401(k)
- 401(k) rules permit loans up to 50 percent of your total savings, up to a limit of $50,000.
- The interest rate is generally prime plus a percentage point or two (so about
5 percent today) which is lower than the average interest charged on a credit card advance (now averaging 13 percent) or a payday loan (36 percent and up).
- You may be required to pay a loan origination fee, 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.” You will then need to pay applicable taxes and penalties on the “withdrawal” amount.
For more information, check out this article and additional links on the Daily Finance website.