As an employee benefits practitioner, I have long argued against participant loan features in 401(k) and other tax qualified retirement plans. When employers insist on participant loan availability, I encourage them to consider adoption only in the case of a participant’s financial hardship. The consequences of 401k participant loans are numerous:
- Once a plan disburses loan proceeds, participants are out of the market and forego potential upside investment returns
- Participants repay loans on an after-tax basis, frequently through payroll deductions
- Loan interest is not tax-deductible, as it is considered ordinary consumer debt
- Generally, if participants terminate employment prior to repaying the loan, the balance becomes immediately due, or the loan is deemed a taxable distribution with a 10% penalty, if the participant is under age 59 ½.
However, a strategy exists for which a 401k loan could help investors who maximize annual 401(k) contributions to accumulate greater wealth and take advantage of a tax deduction opportunity. This strategy is intended only for experienced investors as it is complicated and involves considerable risk. Continue reading