Borrowing money out of your 401k can prove to be a beneficial strategy to eliminate debt, fund a business, or even to get money to expand the kitchen. In this article I want to explain the general rules, some of the benefits, and how using a loan against a Self-Directed 401k could be a much more beneficial way to borrow against 401k plans.
Borrow Against 401k Plans: The Basics
In general you can borrow the lesser of $50,000 or half of your portfolio.
The general loan length is 5 years.
- Some variations can occur, like if you use the funds to purchase residence
No credit check required.
Pay off the interest, to YOURSELF.
- That is right, Most of the interest you pay back is deposited right back into your account. Imagine having $25,000 in credit card debt and paying 10%, 15%, or even 25% interest on it. Borrowing against your 401k could help you pay off that debt NOW, and pay it off for less than 5% interest. The best part is that the interest is paid to you, not the credit card company!
Here are another couple things to note:
The amount that you take out of the 401k will not take part in the investment growth of your portfolio.
Depending on the type, there could be different tax implications when you borrow against 401k plans.
- A traditional 401k that is set up with your employer will have you pay taxes on the money you loan to yourself (it is income) and then when you repay yourself you are subtracting your income by the repayment amount. Talk about a double whammy! This is the case UNLESS you have a Roth 401k, and yes there is such a thing. This is probably the best time to transition to the best part of this article.
The Individual Self-Directed 401k
Just like a self-directed IRA, and Individual Self-Directed 401k allows more flexibility in investment options. You can use your “Indi-k” to invest in real estate, raw land, corporations, and of course stocks and mutual funds. The difference is that with an Indi-k you can take a loan against.
The loan rules are similar to what we discussed above: you can take a maximum of $50,000 out of the account (or half your portfolio, whichever is lesser) and you get to pay yourself back the interest. A HUGE difference is that since it is an INDIVIDUAL 401k, you can set it up as a Roth account. Now, if you know anything about Roth accounts it is that they operate differently when it comes to taxes. With an Individual Roth 401k, you pay taxes on the contributions. That means that when you take the loan out of your Indi-401k, you won’t pay taxes on it because you already paid taxes when you contributed those funds. You pay yourself back PLUS interest.
Now, the Individual Self-Directed 401k has many benefits, rules, and regulations; too much to get out in just this article. However, Horizon Trust has put together a very impressive portion of their site dedicated to this concept. It is complete with videos and FREE downloadable content. Head over to their site to take a look.
If you are new to the self-directing concept, then please check out some of our other content.
Before anyone takes out a loan to borrow against 401k plans, it is important to discuss all the rules and regulations with a professional. Although this option has many benefits, it may not be the best route to take for some people. With that said, USelfDirect has a team of people that would be happy to answer any questions that you might have before you make any kind of decision. Feel free to give us a call today!