Examine the potential advantages and downsides of a loan from a 401(k)
Discuss factors that you will need to consider before deciding to take a loan from your 401(k) plan
Why Borrow from a 401(k)?
Individuals borrow from their 401(k) plan when there is a real need and when other sources of funds are not readily available or are too costly.
They also borrow from their plan to:
Pay for college tuition
Cover uninsured medical expenses
Fund the purchase of a primary residence
Prevent being evicted or defaulting on a mortgage
What Is a 401(k) Loan? Principal & interest payments Loan amount 401(k) Plan 401(k) Loan Loan amount Principal & interest payments Traditional Loan Bank or other creditor
How Much Can I Borrow?
Minimum account balance
Minimum loan amount
Maximum loan amount, greater of:
100% of vested balance up to $10,000
50% of vested balance up to $50,000
Adjustment for multiple loans
Maximum loan amount less the highest outstanding loan balance within the preceding 12 months
Account Balance Maximum Loan $0 – to Minimum Balance $0 Minimum Balance – $19,999 100% of Account Balance up to $10,000 $20,000 – $100,000 50% of Account Balance Over $100,000 $50,000
How Much Can I Borrow? – Example Vested Balance Highest Loan Balance in Past 12 months Maximum Loan Amount $60,000 $0 $30,000 Vested Balance Highest Loan Balance in Past 12 months Maximum Loan Amount $50,000 $9,000 $16,000
Terms of the Loan
No taxes or penalties on loan amount
Interest not tax-deductible
Repayments taxable as ordinary income upon withdrawal
Taxable as distribution upon default
Tax Treatment – After-Tax Payments
Interest paid to yourself
Ability to select source of funds
Longer repayment period for home loans
Temptation to reduce contributions
Required repayment if you leave employment
Interest not tax deductible
What Happens if I Default? Default on Outstanding Loan Balance of $20,000 Federal income tax (28%) $5,600 State income tax (5%) $1,000 10% early withdrawal penalty $2,000 Total Taxes and Penalties $8,600
Impact on Retirement Goals
Choosing the source of funds
Importance of continuing contributions
Example – No Loan with Continued Contributions Hypothetical example Assumes 8% annual rate of return Starting Balance $40,000 Annual Contributions $5,400 Ending Balance after 30 Years $1,040,432
Example – Loan with No Contributions during Repayment Hypothetical example Assumes 8% annual rate of return Starting Balance $40,000 Loan Amount $20,000 Annual Loan Payments (5 Years) $4,529 Annual Contributions during Repayment Period $0 Annual Contributions after Repayment Period $5,400 Ending Balance after 30 Years $802,688
Example – Loan with Continued Contributions during Repayment Hypothetical example Assumes 8% annual rate of return Starting Balance $40,000 Loan Amount $20,000 Annual Loan Payments (5 Years) $4,529 Annual Contributions during Repayment Period $5,400 Annual Contributions after Repayment Period $5,400 Ending Balance after 30 Years $1,028,936
Example – Comparison 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Years No loan with continued contributions Loan with no contributions during repayment Loan with full contributions during repayment $1,040,432 $802,688 $1,028,936 Hypothetical example Assumes 8% annual rate of return $0 $200,000 $400,000 $600,000 $800,000 $1,000,000 $1,200,000 Account Balance
Should I Borrow from My 401(k) Plan?
How important is your need for the loan?
Can you obtain the needed funds from other sources?
Are you planning to leave your job within the next few years?
Is there a chance you will lose your job due to a company restructuring?
Will you be able to continue to make regular contributions to your plan?
Your Financial Advisor Team at Morgan Stanley Smith Barney
Our Financial Advisors can provide:
Access to intellectual strength and global resources of Morgan Stanley Smith Barney
Financial solutions that address your specific needs and goals
Tom Kokjohn, CFP Financial Advisor
Morgan Stanley Smith Barney, Morgan Stanley & Co. Incorporated and Morgan Stanley Smith Barney’s Financial Advisors do not provide tax or legal advice, are not “fiduciaries” (under ERISA, the Internal Revenue Code or otherwise) with respect to the services or activities described herein, and this material was not intended or written to be used for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Individuals are urged to consult their tax or legal advisor before establishing a retirement plan or to understand the tax, ERISA and related consequences of any investments made under such plan.