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Considering the high interest rates that apply to many credit cards, would it be smart to borrow from your 401(k), 403(b), or 457 plan instead?

Borrowing from retirement savings is fairly common. About 60% of 401(k) plans have loan provisions. At any given time, almost one-fifth of workers who have access to loans have an outstanding loan balance.1 But just because you can get a loan doesn’t mean you should. Borrowing from an employer-sponsored retirement plan involves rules and risks that should be considered carefully.

Know the rules. Under IRS rules, loans are limited to the lesser of $50,000 or 50% of the vested account balance. Loans must be repaid within five years (longer terms may be allowed for a home purchase). However, each plan is allowed to set its own interest rates and repayment policies. The good news is that even though the plan is required to charge interest, the interest is paid to the borrower’s account.

Understand the risks. If you leave your employer, the loan generally must be repaid within 60 to 90 days. Failing to repay on time means the outstanding balance may be treated as a distribution. Distributions from employer-sponsored retirement plans are subject to ordinary income tax. Early withdrawals taken prior to age 59½ may be subject to a 10% federal income tax penalty.

Of course, borrowing from your retirement plan could be a better option than carrying high-interest debt. But it’s usually recommended to consider a loan only in an emergency, not to maintain a lifestyle you cannot afford.

Source: 1) Employee Benefit Research Institute, 2010

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