People are now taking loans out against their 401K's when a big expense arises because there's no cost to that loan as the interest goes back into their account. However, this can hurt people in a couple of different ways, according to Erik Carter, Senior Resident Financial Planner with Financial Finesse.
The money taken out will no longer be earning and growing for them and if they leave that company, whatever is not paid back in about 60 days is considered a withdrawal, taxes upon which must be paid, along with a 10% penalty if you're under the age of 59 1/2. Any money one would be saving by paying the interest back to themselves, they could be losing in penalties and lost earnings, Carter says.
One of the good things of a retirement plan loan is that you have to pay it back as it's taken out of your paycheck. Of bigger concern, Carter points out, is a hardship withdrawal, which cannot be paid back even if one wanted to and is subject to taxes and penalties.
The ideal situation, of which most people are not aware, according to Carter, would be to have an emergency fund set aside outside of a 401K and one way to do this is through a Roth IRA, which allows you to access the contributions anytime you want without tax or penalty.
Erik Carter, Senior Resident Financial Planner with Financial Finesse, spoke with Retirement News Today, providing online retirement news video content. Retirement News Today is a featured network of Sequence Media Group.