401(k) Can Be a Great Source for Loans

Looking for a good source of funds to buy a car, pay your kids’ college expenses or make a down payment on a house? Consider borrowing from your good old 401(k) company savings plan at work.

These popular savings accounts, to which you can contribute pretax dollars from your wages or salary, are often far superior as a source of loans than other kinds of personal loans, although new Labor Department rules may complicate that somewhat.

Through a 401(k) loan, you simply borrow from monies already vested to you in your account. You must pay interest, as with any other loan, and pay the loan back, usually within five years.

“For most employees, it’s the best loan source they’ll have,” says Duane Bollert, head of the Los Angeles office of Hewitt Associates, an employee benefits consulting firm. “Companies try to make these as available and flexible as possible,” Bollert adds.

Here are some of the key advantages of 401(k) loans over personal loans from a bank or other financial institution:

- You can borrow large amounts. Under new Labor Department regulations, you can borrow as much as half of your vested funds, up to $50,000. Because some employees have as much as $40,000 in their accounts--including funds contributed by their employers, who often match employee contributions by 50%--that can allow for a pretty nice-sized loan.

- You generally can get a lower interest rate. Many companies allow interest rates as low as the prime lending rate at banks, far lower than you can get on a credit card, home equity loan or other personal loan.

- The interest you pay is paid to yourself. That’s right, since you in effect are borrowing your own money, the interest payments go back into your account, not to the company.

- You generally don’t need a credit check. And why should you? You are borrowing your own money, and the unborrowed funds remaining in your account serve as adequate collateral. If you fail to repay, the unpaid balance will be treated as a withdrawal. You will be taxed on any pretax amounts and pay a 10% penalty if you are under age 59 1/2.

- Paying back is convenient. Virtually all companies allow repayment through payroll deductions.

Most companies, and the government, only place a handful of restrictions on the loans. Among them: Loans carry a five-year maturity, with a fixed rate of interest. But you can use the money for anything--from buying a boat to paying your children’s college tuition. Loans of longer than five years’ maturity must be used for home loans and generally carry maturities of 10 or 15 years.

Some companies impose additional requirements, such as $1,000 minimums on amounts borrowed. Some companies also require spousal consent for loans. But many firms will allow you to borrow more than once from your account, if, say, you borrowed a few years ago and wish to borrow again now.

These and other advantages make such loans attractive for companies as employee morale boosters. Nearly two-thirds of firms that offer 401(k) plans allow loans from them, according to a Hewitt Associates survey.

Companies also like 401(k) loans because they encourage employees to contribute to the plans, knowing that they can have access to their money if some unforeseen financial emergency crops up. Withdrawing money from 401(k)s outright can be extremely difficult, only possible after you prove hardship and if your employer doesn’t allow loans from your account.

However, the new Labor Department rules governing loans from 401(k)s and other pension plans, issued last month, will add some changes, not all of which are favorable.

One key change requires that loans made beginning Oct. 18 carry an interest rate “similar” to that on commercial loans. That could end up raising rates slightly.

Also, loans must be made available to former employees who keep accounts at their former employer. However, the regulations are very unclear as to how this will work.

Another concern with the new rules: Non-compliance may disqualify a company’s entire 401(k) plan, thus subjecting you to taxes on your pretax contributions, says Phil Billard, a partner and attorney at Hewitt Associates.

That will force companies to be super careful about compliance, Billard says. The chances of entire plans being disqualified “are very remote,” he says.

Bill Sing welcomes readers’ comments and suggestions for columns but regrets that he cannot respond individually to letters. Write to Bill Sing, Personal Finance, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.