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“Do I Need To Pay Taxes On Money Borrowed from a 401(k)?”

Prepare money to pay tax for the income tax returnsIf you have a 401(k) with your employer, did you know that you can borrow money from it? Well, you can. There are several reasons why this might make sense. First, you can borrow up to $50,000 or half of what you have in your 401(k) account, whichever is less. Second, you do have to pay interest on the money but you’re paying interest to yourself. Plus, the interest you would have to pay will be much less than a credit card. In fact, it will probably be the prime rate plus 1%.

Five years to pay back the money

Another advantage of borrowing from your 401(k) is that you will have five years to pay back the money. Of course, this assumes that you stay with your same employer for the entire five years. If you were to leave that employer, you would then have to pay back the money within 60 to 90 days. Any money you were unable to pay back within that two to three months would be treated as an early withdrawal and taxed as ordinary income plus a 10% tax penalty.

No taxes

You won’t need to pay taxes on any money you borrow from your 401(k), assuming you pay the money back within the five-year time frame. As noted above, you will have to pay interest on the money but you don’t even have to report your loan to the IRS.

The downside

There is a downside to borrowing money from your 401(k) as your interest payments are subject to double taxation. You pay the interest with after-tax dollars and are then taxed again when you withdraw the money in retirement.

Do you have a whole life insurance policy?

If you have a whole life insurance policy and have had it for a number of years, it probably has a cash value. In this case, you might be better off borrowing from it. For one thing, you can take as much time as you like to pay back the money. In fact you don’t have to pay it back at all. However, if you were to die before you repay your loan, the money would be subtracted from your policy’s face value. This means your heirs would get less money. For example, if your policy had a face value of $100,000 but you had borrowed $20,000, your heirs or estate would get only $80,000.

Consider credit counseling

A third option is to go to a consumer credit counseling agency. This is the choice of many families because it’s a way to consolidate debts without having to borrow more money. The best credit counseling agencies are nonprofits and either charge nothing for their services or very low fees. While borrowing from your 401(k) can seem very attractive, it does have its negatives. Given this, it might be best to go to a credit-counseling agency for help before you tap into your retirement fund.

By Samantha Seiffert
I am a personal finance blogger for National Debt Relief, a Debt Management Company that has helped thousands of Americans facing credit card debt problems. We help with debt settlement, debt management, and other debt related financial crisis' facing con

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