While the 401(k) is supposed to be a retirement plan, there are ways to get your money out while you're still working. Some plans let you borrow money from your account for anything you want, including buying a car. Before taking a loan from your 401(k), make sure you understand the repayment terms, because a badly handled loan can seriously derail your retirement plan.
Not all 401(k) plans offer loans. When your employer launched your company's plan, he decided whether or not to permit loans. You can only borrow money from your 401(k) if it allows loans. If you can borrow from your 401(k), the IRS limits the amount you can borrow. If you have $100,000 or more in your account, you borrow up to $50,000. If you have less than $100,000, you can borrow up to half your account balance. For example, if you have $80,000 in your 401(k), you can only borrow up to $40,000.
You need to repay your 401(k) car loan within five years. If you don't, it will count as a withdrawal and the IRS will charge you taxes and penalties. You also need to pay interest on top of the loan balance. Your loan repayment schedule depends on your employer. Some plans let you make quarterly payments, while others require monthly payments. Some companies also let you use an automatic payroll deduction to make your loan payments. This makes sure you never miss a payment and default on your loan.
401(k) Loan Advantages
A 401(k) car loan has several advantages over other types of debt. You don't need to pass a credit check to borrow from your 401(k), so you are guaranteed to get this money. A 401(k) loan also generally charges a lower interest rate than a regular car loan. Lastly, you are paying your loan back to yourself. Both the interest and principal payments go back into your 401(k), so you'll be able to use this money in the future. You're financing the car purchase yourself and not relying on a creditor.
401(k) Loan Disadvantages
The biggest problem with a 401(k) loan is the cost of not paying your loan on time. If you don't pay your loan back, the IRS counts the loan as a withdrawal. You'll owe income tax on the entire loan amount, and if you are younger than 59 1/2, you'll owe another 10 percent penalty on the loan. You also won't be able to invest in your 401(k) for the next six months. If you quit your job, you need to repay the entire loan immediately or it counts as a withdrawal. Also, if the financial markets increase significantly, you lose the ability to make gains on the money you took out as a loan.
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