In companies with more than 500 employees, more than 90 percent of workers participate in a 401(k) plan. And in 95 percent of these plans, employers made a matching contribution in the past year. 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 on hard times, they tend to tap into their 401(k) plans. In fact, more than 1.4 million Fidelity participants borrowed against their accounts in 2020.
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)
- 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 4-5% today), still lower than the APR charged on a credit card advance (now averaging 20%) or a payday loan (400% and up).
- 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.