What are the things you need to know before taking out a 401(k) loan?

Q. I am currently in a tight financial situation. The company I have worked in for over ten years offers a 401(k) plan to its employees. I was thinking of taking out some amount from my 401(k) account as a loan. However, I have heard that this may not always be the best option. I wanted to know more about how a 401(k) loan works, and any other thing that will be of help. Scott, Wisconsin

Hi Scott, while you may be tempted to take out a 401(k) loan, it is true that it may not always be the best option since failure to repay will have serious consequences. Consider it your last resort if you have no other options. Many people think that since you are borrowing your own money, it is a simple process. But the truth is that taking out a 401(k) loan is not as simple as it sounds.

If you still think that borrowing from your 401(k) plan is the way to go, then there are some things to keep in mind. The first thing you have to check is how much you can borrow. Usually, the limit is set to 50 percent of your retirement plan or $50,000 – whichever is the lesser amount.

When borrowing from your 401(k) plan, you don’t have to go through a credit check since you are taking out your own money; no financial institution is loaning you the money.

However, even though you do not have to run a credit check, you still have to pay the interest. The interest rate depends upon your loan plan, which is usually based on the current industry rates. Apart from this, taking out a 401(k) loan will also require you to follow a strict repayment schedule. This means that you have to pay back your loan, along with interest, within five years. However, if you use the loan to buy a home, the period for repayment is usually more than ten years.

Lastly, make sure that you do not miss any of your payments. Failure to repay your 401(k) loan on time will have some serious repercussions. If you miss a payment, your employer will regard it as you withdrawing from your 401(k) plan. This means that not only will you have to pay taxes on the loan you take out but also pay the penalty for withdrawing from your retirement plan early.

Expenses Associated with Setting Up a 401k

As the owner of a women’s boutique, I feel its high time that I set up a 401k for my  employees. But before I proceed, I would like to know what are the expenses involved in administrating a 401k? Marcie Maughan, Tennessee

What you are doing is absolutely right- it is smart to understand the kind of expenses that go into setting up a 401k for small business owners. You must ensure that the fees you pay to your 401k service provider are reasonable in lieu of the quality and level of the services provided. As a thumb rule, 401k expenses can be widely categorized into administration fees, investment fees and individual fees linked to an optional feature of your 401k plan.

The administration fee is charged for all the daily administrative work associated with managing your 401k, such as accounting, record keeping, trustee services, legalities, and other aspects that go into administering your plan. Additional services such as investment advice, online transactions, or any sort of electronic access may also add to your overall fees. In some cases, these fees will be deducted from the return on investment, and in others they will be charged separately. For a one-time set up fee with no hidden charges, you can consider an online 401k set-up like http://small401k.com for your small business.

Investment management is one area that accounts for most of the expenses related to your 401k. A certain percentage of the invested assets may be charged for services that are investment-related. This is directly debited from the return on investment, and your net return is what you get after a deduction of the investment fees. Understand the expenses related to your 401k investment management to make an informed decision. Individual fees are charged for the optional features you choose when designing your 401k plan; this includes taking out a loan against your 401k or a participant investment choice.