AFM Reader Question on 401(k) Loans

July 13, 2009

I received the following email over the weekend:

Hi,

Your article on 401(k) loans was very informative.

I am trying to decide between 401(k) loan and withdrawal. My 401(k) is not currently active, meaning I do not contribute anything towards it. I have moved to a new employer and my 401(k) was with the old employer.

I am looking to arrange funds for about 10K. I would be grateful to you if you could let me know which option is better?

Thank you,
M.

M.,

First off, you can’t take a 401(k) loan from a 401(k) with a former employer. Had you had an existing loan on your 401(k) when you left your previous company, you would have had to either pay it back or pay taxes and a 10% penalty on the outstanding loan balance.

Now, it might be possible to move your old 401(k) into your new company’s 401(k). Then, it might be possible to take out a loan through your new company. You’ll have to check with your new company’s human resources manager to find out the specifics.

I don’t recommend the withdrawal route because you’ll be taking a 30% haircut on the withdrawal (20% withholding plus a 10% penalty). On a $10,000 loan, you’re looking at losing $3,000. That’s a lot of money.

One last thing I want to address is your reasoning for withdrawing money from your 401(k) in the first place. You don’t mention your reason in the email. I hope it’s for a good reason (perhaps to purchase a house). By withdrawing money now, you are forfeiting future growth on the withrawal, which could be significant. At least with a 401(k) loan, you are paying yourself back in a relatively short time period.

My recommendation is that you try to find the money some other way if you can’t do a loan. If there’s any way possible to avoid withdrawing funds from your 401(k), go that route.

One response to AFM Reader Question on 401(k) Loans

  1. Wanted to add 2 things:
    1) If you do roll it into an IRA you CAN NOT take a loan

    2) An option may be if you have cash value life insurance policy where you can take a loan from.