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.

Fiduciary Responsibilities Explained

What are ‘fiduciary responsibilities’ and what do they have to do with my small business 401K plan? –Mitch Campbell, Oklahoma- Owner of a cake shop chain

A retirement plan is a valuable benefit that you offer to your employees. Your staff and their beneficiaries gain some great advantages with a small business 401K plan and so do you, the employer. As the employer setting up the account, you have some responsibilities to meet too. The Employee Retirement Income Security Act (ERISA) outlines the responsibilities you need to meet when managing the 401K plan and its assets, also called fiduciaries.

When you first set up your 401K plan you also create a plan outline that describes it exhaustively. This plan also gives a guideline to operating the plan, managing it and tracking it. Carrying out these responsibilities in line with the plan document is your primary fiduciary responsibility. Different people, involved in some way with your 401K plan may bear different kinds of fiduciary responsibility depending on the functions that they carry out for the 401K.

Some examples of fiduciary responsibility are carrying out investment with the participants’ best interests at heart, ensuring that unnecessary expenses are not incurred etc. Failure to adhere to your fiduciary responsibility can make you liable to making good any losses sustained by the plan’s participants owing to your negligence.

You can however limit your liability by documenting all your actions and related processes to show that you have fulfilled your responsibilities to the best of your ability. Using a software suite like http://401ksolution.com helps you keep informed about ERISA guidelines so that you can always be in compliance with the law.

What is ERISA?

What is ERISA and why should I know about it if I want to set up a 401k plan for my small business?- Anna Kramer, Connecticut

ERISA stands for the Employee Retirement Income Security Act of 1974. This is a federal law that outlines the standards that apply to retirement plans for private businesses like yours. While ERISA does not make it mandatory for you to set up a 401k for your employees, it does require that some minimum standards be met if you do have such a retirement benefit plan for your business.

This Act covers health and other welfare plans in addition to retirement plans like 401k. The responsibilities that you have to meet with regards to your small business 401k are clearly outlined by the ERISA which is why you need to be familiar with this 1974 Act to ensure compliance. The Department of Labor website has detailed information on ERISA that you can use to understand more about this act and how it affects you.

Non compliance with ERISA’s fiduciary responsibilities can make you liable to make good losses sustained from your negligence. But this need not put you off from setting up your own 401k plan for your small business. ERISA requirements are quite straight forward, making it easy to comply with them.

By using a software suite like http://401ksolution.com you can ensure that you are kept updated about any changes to this act. This suite also has in- built record keeping and report generation features that make mandatory government reporting simple.