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If you have a 401(k) loan and lose your job, another of the financial myths is that you'd have to sell your home to repay the loan. First, you'll have 60 days to pay back the money, which might be enough, depending on the size of the loan. What this suggests is that you should feel you're really stable in your job before borrowing money from your 401(k). Beyond this, your 401(k) plan may give you extra time to pay back that loan if you lose your job. If you absolutely cannot come up with the money to repay the loan, then the unpaid loan amount will be subject to an early distribution penalty of 10% and you'll have to pay ordinary income tax on the money. Those might not be totally serious consequences but they certainly beat having to sell your house to pay back loan, which is what some scare mongers would have you believe.
If you're still uncertain about borrowing from your 401(k), here's a brief video from Fidelity that discusses the pros and cons and well as some alternatives.
Frequently Asked Questions About 401(k)s
Q. What is salary deferral?
A. The simplest explanation of salary deferral is where you take some of your income and set it aside for later. The contributions you make to a 401(k) plan are normally made on a tax-deferred basis, meaning that your income is reduced by whatever amount of money you contribute to your plan. In short, you are not taxed on the money you contribute in any year you make a contribution.
Q. What is the 401(k) maximum this year?
A. The amount you can contribute to your 401(k) is limited by the IRS. And the amount is not a percentage of your salary. It's a fixed number that applies to everyone. For example, this year the maximum yearly contribution for a yearly employee is $18,000 If you are under the age of 50. If you are older than 50 the maximum contribution goes to $24,000.
Q. What is a 401(k) Roth?
A Roth 401(k) is a sort of a hybrid that combines the features of a 401(k) plan with the Roth IRA. The biggest difference between it and a standard 401(k) is that the money you contribute is post-tax, which means that you will be required to pay taxes the year you contribute to the plan but the money will be tax-free when you retire and begin making withdrawals. It is similar to a standard 401(k) in that your employer may contribute matching funds.
Q. What does 401(k) stand for?
A. This plan was created under subsection 401(k) of the Internal Revenue Code, hence the name 401(k). If you sign up for your employer’s 401(k) plan the money you contribute will be automatically deducted from your paycheck before taxation, making it tax-deferred. However, unlike the Roth 401(k) plan the money will be taxed when you retire and begin making withdrawals.
Q. What is a 401(k) elective deferral?
A. Elective deferrals are the amounts you ask your employer to deduct from your pay and contribute on your behalf to the employer’s retirement plan. This is where you are setting aside part of your earnings pretax meaning that you won’t be required to pay taxes on your contributions. It is called an elective deferral because you get to elect how much you want deduced from your pay.
Q. What are 401(k) eligible earninggs?
A. The IRS generally usually sees eligible earnings as your gross income. However, depending on your employer this may or may not include bonuses. It doesn't include supplemental benefits such as health insurance or a commuter allowance. You are allowed to contribute part of your eligible earnings to your 401(k) account, which increases every year. This year, as noted above, the maximum you can contribute of your eligible earnings is $18,000.
Q. What is 401(k) matching?
A. If your employer provides matching funds then 401(k) matching is the amount of money that it contributes to your 401(k). Typically, an employer will match 50% of your contributions for the first 6% of your salary that you contribute. This means the company is not matching more than 3% of your salary. However, some employers will match less than this.