Pulling money out of my 401k

[Chris Fethke]

I want to take funds out of my 401k to help start my first investment. I will be paying back into my 401k over 3 years. Will this be a wise decision? Is there a way to take funds out without getting hit with taxes?

[Brian Eastman]

@Chris Fethke

As noted above, you can typically borrow from a current employer 401k plan. You would not be able to borrow from a former employer plan, but could roll that to a self directed IRA or 401k.

The specific loan terms are specified by your plan document, but will generally look like the following.  Check with your plan administrator.

• You may borrow the lesser of 50% of your participant account value or $50,000.
• The loan is for a 5 year term
• Rates are generally in the range or prime + 1-3 points.
• There is no penalty for pre-payment of a loan.

So long as you repay the loan according to the terms, there are no restrictions as to how the funds may be used and there are no taxes or penalties. If you fail to repay the loan, it is considered a distribution and taxed accordingly, including early distribution penalties if applicable based on your age.

If you change jobs, you will be required to pay off the loan immediately or it will be considered a distribution as above.

Keep in mind, you put funds into the 401(k) plan on a tax-deferred basis. While you do not incur taxes for accessing the funds, you will be replacing the borrowed money with after-tax funds, so there is a loss of tax-deferral on the basis that you borrow. If your tax rate is 30%, you are effectively creating a -25% ROI for the funds borrowed from the 401k.

As such, a 401(k) loan is typically only a good resource for an activity that will really benefit you long term such as growing a business, and when other sources of credit may not be available.