PRACTICAL MONEY SKILLS: Avoid tapping retirement plans early

Published: Tuesday, March 25, 2014 at 11:21 AM.

I have yet to meet anyone who thinks they're saving too much money for retirement. On the contrary, most people admit they're probably setting aside too little. Retirement accounts must compete with daily expenses, saving up for a home, college and unexpected emergencies for every precious dollar.

If taking money out of your IRA, 401(k) or other tax-sheltered plan is your best or only option, you should be aware of the possible impacts on your taxes and long-term savings objectives before raiding your nest egg:

401(k) loans

Many 401(k) plans allow participants to borrow from their account to buy a home, pay for education, medical expenses or other special circumstances. Generally, you may be allowed to borrow up to half your vested balance up to a maximum of $50,000 – or a reduced amount if you have other outstanding plan loans.

Loans usually must be repaid within five years, although you may have longer if you're using the loan to purchase your primary residence.

Potential drawbacks to 401(k) loans include:

  • If you leave your job, even involuntarily, you must pay off the loan immediately (usually within 30 to 90 days) or you'll owe income tax on the remainder – as well as a 10 percent early distribution penalty if you're under age 59 ½.
  • Loans cannot be rolled over into a new account.
  • Some plans don't allow new contributions until outstanding loans are repaid.
  • Many people, faced with a monthly loan payment, reduce their 401(k) contributions, thereby significantly reducing their potential long-term account balance and earnings.
  • Your account value will be lower while repaying your loan, which means you'll miss out on market upswings.


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