401k and Some Most Common Mistakes

Some of the most common mistakes related to 401k accounts are taking a loan against 401k, cashing your current or old 401k account or using inappropriate investment vehicle for your 401k assets.

Considering ramifications of taking a loan against 401k, there are several things to consider before borrowing against your retirement: various fees and loan interest rate, double taxation, the diminished power of compounding and consequences in the case of termination or resignation.

Some 401(k) plans do not allow you to continue making contributions until the loan is fully repaid. This would cause you to miss out on tax-deferred contributions and the earnings you could receive on those contributions to your retirement account. You could also miss out on employer matching contributions.

While regular 401(k) contributions are taken out of your paycheck on a pre-tax basis, the loan repayments are not. This means that you are taking pre-tax money out of your account and then repaying it with after-tax money.

If you resign or are laid off your job, or your company closes its doors before you repay your loan, the IRS will consider your loan an “early distribution” of retirement savings. The loan’s outstanding balance will be treated as income, and you will be required to pay income taxes plus early withdrawals penalties.

Before jumping into a 401(k) or 403b loan, make sure you consider all of your other options first and have a full understanding of what borrowing from your retirement plan will really cost you.

Cashing out a 401(k) account is rarely a smart idea. Typically, you face income taxes on the distribution, a 10% penalty if you are younger than 59½ years old, and 20% withholding—plus you give up the opportunity for continued tax-deferred or tax-free (if ROTH 401k) compounding of your assets. Your other options are: leave the money in your old 401k plan, transfer money to your new employer’s plan (if new employer allows) or roll over into an individual retirement account (IRA). The key considerations are: a plan’s costs, investment choices, account access and the ROTH option.

Before making any decision concerning your old 401k, you should first talk to your trusted financial advisor who will help you make the right decision in the context of your overall financial picture, your age, risk tolerance, time horizon, asset allocation and diversification.

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* It is not the intent of Dee Turkalj to provide tax advice. Gold Coast Securities, Inc, its affiliates and agents are not in the business of providing tax advice. Please contact your tax advisor with all questions regarding how anything discussed above may affect your tax situation.