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Financial Challenges Associated With 401(k) Loans

Posted on August 20th, 2014

A recent study reported that a quarter of the population has borrowed from their retirement accounts. Borrowing from a 401(k) at an attractive interest rate to pay off high-interest credit card debt could make sense, but there are disadvantages. One risk is the loss of asset protection for the 401(k) in case of a personal bankruptcy. Another disadvantage is the loss of additional earnings the borrowed money could have been adding to your retirement account.


The popularity of 401(k) loans has increased as banks and credit card companies have reduced consumer credit limits in the wake of the struggling economy. In contrast, Arizona consumers can borrow up to 50 percent of the balance in a 401(k) but not more than $50,000. Low fees and attractive interest rates add to the popularity of a 401(k) loan, but there are risks a consumer should know about before borrowing.


As businesses struggle, the risk of unemployment has increased for many consumers. A 401(k) loan is due and payable when the borrower leaves the company, usually within a few months. If the loan is not repaid, there could be income tax penalties and consequences if the borrower has not reached age 59 1/2.


Borrowing from a retirement account to pay off high-interest rate credit card debt could be a sound decision if accompanied by a commitment to limiting future credit card use. Borrowers who allow credit card debt to continue unchecked risk being unable to repay either their credit cards or the loan they just took against their future retirement.


Arizonans experiencing financial challenges who is considering filing for bankruptcy should consult with an  Arizona bankruptcy attorney before taking out a loan against a retirement account. A retirement account may be a protected asset in a bankruptcy, but borrowing against it might cause it to lose the protected status.   In a Chapter 13 bankruptcy, you are allowed to continue paying the 401(k) loan until it is completely paid.  The guidance and advice of a bankruptcy attorney may prevent a person from making a costly mistake.


Source: KARE 11, “Knowing about borrowing from your 401(k),” Jan. 24, 2013


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