The 401k retirement plan is a special type of account that invests in different asset classes such as stocks, mutual funds, and bonds, which are not taxed on any interests, dividends or capital gains when withdrawn on maturity. Although the main purpose of 401k account is to secure financial solvency for the retirement years, for people who face short-term liquidity problems and may not have alternative options, the government has allowed the offer of 401k hardship loans.
To be eligible for a 401k hardship loan, a 401k participant should be able to prove a financial need that is ‘immediate and heavy’ and may include the need of the employee, his/her spouse or dependent(s). By the clause ‘immediate and heavy’ financial need, the employee has to prove to the employer not only the severity of the situation, but also the lack of alternative options to meet the need in order to be allowed to borrow against the 401k account.
Likewise, the amount requested must be proper to meet the financial need. This means that the employee must request an amount of 401k hardship loan that matches the total of the financial need that cannot be met with any other source of funds. Typically, employers request employees to certify that they can meet the 401k plan’s requirements for a 401k hardship loan. This means that employees are rightfully justified to request a 401k hardship loan for the following reasons:
(1) to purchase their first property (first-time home buyers),
(2) to cover the costs of higher education for a family member (college tuition),
(3) to prevent eviction due to foreclosure on their property (home mortgage or bankruptcy), and
(4) to pay un-reimbursed medical expenses that cannot be covered by another source
Typically, a 401k hardship loan is minimum $1,000 and maximum the 50 percent of the account balance up to $50,000, while the repayment occurs evenly over a period of 60 months (5 years) or in the case of a home loan, up to 15 years.
401k hardship loans have numerous advantages. First of all, they are not subject to governmental restrictions or any taxation. Any interest paid on the loan, it actually goes back to the loan, while interest rates are extremely competitive even for people with poor credit history. In case of default, the employee will forfeit the interest and dividends on the borrowed amount as well as the lifetime tax value and would pay the 10 percent penalty on the withdrawal amount. This means that borrowing from 401k account has no impact on the employee’s credit history. If the employee pays back the borrowed amount on a short-term horizon as scheduled, it will have a minor impact on the retirement savings progress, while it will definitely have a positive impact on the savings account.
On the other hand though, one of the major disadvantages of a 401k loan is the fact that some of these loans inhibit contribution to 401k retirement plan until full repayment. This means that if the employer matches the 401k contributions, the employee definitely loses money until the loan is repaid. Besides, the interest rates on 401k hardship loans are not tax deductible. And, finally, from a financial point of view, financial planners consider that 60 months is a short term period for repayment if one compares 401k loans to personal or equity loans.
In any case, when borrowing the proper amounts of money for a short-term period, 401k hardship loans may be the lowest-cost source of funds available. On the other hand, a 401k hardship loan is like borrowing against own financially-secure retirement. In any case, if one is going to get a 401k hardship loan, it should really be used as last resort option. If there is really no other alternative, then it makes sense to request a 401k hardship loan, but while keeping in mind that it might being hardships along the way.
http://www.money-zine.com/Financial-Planning/Retirement/401k-Loans/
