If you're currently employed at a workplace that offers the option of a 401(k) loan to employees, you may be debating taking out such a loan to launch your own side business or purchase a piece of rental real estate. While these loans can have a number of advantages for those who don't have the cash flow or non-retirement reserves to take on any additional business debt, they're also subject to some strict rules and regulations that may impact your decision. Read on to learn more about how a 401(k) loan works and what you'll want to keep in mind before signing papers to borrow against your own retirement account.
What is a 401(k) loan?
Most pre-tax retirement savings plans, like 401(k)s, 457s, and IRAs, have some specific age limits when it comes to withdrawing these funds penalty-free. For those who have substantial funds saved for retirement, but not much saved elsewhere, a 401(k) loan can provide a quick infusion of cash without subjecting you to high interest rates or other restrictive terms.
While you have an outstanding loan on your 401(k), you'll be required to make regular repayments, and may not be permitted to continue contributing to the 401(k). This could cause you to miss out on market gains that happen before the loan is fully repaid. However, any interest assessed on the loan is paid to yourself rather than to a bank or another third party, so at the conclusion of the loan period, you may end with a slightly larger amount than you withdrew.
What should you consider when taking out a 401(k) loan to start a business?
One of the key things to remember with regard to a 401(k) loan is that these loans are almost always "called back" when your employment is terminated. This means that if you quit or are fired, you may be required to repay the loan in full within just a month or two of your last day, even if you previously had an agreed-upon payment plan covering a much longer period.
This means you may want to first check with your employer to see if your use of these funds is permissible. If your employer is liable to fire you once it discovers you've started a side business, even if this business isn't related to what you do for a living at your day job, you could find yourself forced to repay the borrowed money before you're even able to use it.
Depending upon the amount you'd like to withdraw, you may also want to consult with a business attorney to ensure you've taken all relevant factors into consideration and have a good handle on how to proceed.
Speak with professionals like Rudolph and Chonoles LLP to learn more.
