By: Aaron Peck, Managing Principal, 1847Financial Dallas | Fort Worth

If you are anything like me, you enjoy digging deep into topics that can significantly impact someone’s financial well-being. A topic that came up in a recent study group was about 401(k) loans. The question at hand: Are they good or bad?

I wish the answer were that simple. The fact is that all financial products, and decisions we make with those products, have positive and negative attributes. To complicate matters further, what might be beneficial for one person could be negative for another. So, in this blog, we will keep things general by focusing on how most of our clients perceive 401(k) loans.

A 401(k) is typically a tax-deferred retirement vehicle. The money goes in before taxes and many employers offer a company match. Upon withdrawal, the money is taxed and may incur a penalty if withdrawn too early.

A 401(k) loan is usually permitted by plan administrators, often allowing borrowing up to $50,000 for a mortgage or to pay off high-interest debt. They are mostly set up to be paid back through payroll deduction with interest over a five-year or less period (longer if used for a mortgage), with a very small administration fee.

The Pros:

· No need to qualify for the loan.
· Low interest rate (1% or 2% higher than the prime rate).
· Tax-free and not reportable to the IRS (as long as you remain employed where the 401(k) is offered).
· Low repayment schedule.
· You pay yourself back with interest.
· Tax effect is similar to using income to repay the debt.

The Cons:

· The money withdrawn is no longer in the market, missing out on potential growth.
· Interest you pay yourself into the 401(k) is taxed twice.
· Separation from employment can cause the unpaid loan to become due, leading to potential taxes/penalties.
· Loan fees.
· Depletion of retirement nest egg.

Whatever your choice, it’s crucial to weigh all the costs, including the lost opportunity cost, when making your decision. I strongly recommend meeting with a Financial Professional before making any decisions so they can help analyze the pros and cons based on your unique situation. If they are anything like my team, they will test their ideas using sophisticated software. I tend to lean towards using the Leap System for most of my tests.

If you’re a financial professional with questions about LEAP software and how Aaron’s firm support its use, consider reaching out directly at (469) 737-4012 or by connecting with Aaron on LinkedIn.

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