Using a 401K Loan to Stop Foreclosure

To avoid a bankruptcy or stop a foreclosure some people will raise cash by tapping their IRA or 401(k). But withdrawing money from a retirement account prior to age 59 ½ can trigger a 10% penalty on top of the regular income tax on the money distributed. Whereas a 401(k) loan that is repaid according to IRS guidelines can avoid the tax hit.

Employees can contact their company's HR department to find out if they have access to a 401(k) loan. Generally after leaving a job one loses the privilege to obtain a loan from a previous employer's 401(k). But, individuals with their own business can still borrow from their retirement funds by setting up a Solo 401(k) plan with a loan option. The Solo 401(k) - also called an Individual 401k or Self-Employed 401(k) - is designed for small business owners with no employees. A Solo 401(k) loan does not require a credit check because you are in effect borrowing from yourself; the loan interest rate is often set at prime rate and stays fixed for the term of the loan. The loan payments, interest and principal, are put back into the borrower's 401(k) account.

It's possible to transfer without dollar limit the funds from an IRAs, 401(k), or other retirement funds into a Solo 401(k) plan. Once the funds are in your Solo 401(k), you can borrow up to a maximum of $50,000 or 50% of the balance in your account, whichever is less. The loan process generally takes a couple of weeks after the funds are in the Solo 401(k) account.

Although a loan from a 401(k) plan is free of tax and early withdrawal penalty if the loan is not paid back on time the IRS will treat the balance of the loan as a distribution subject to taxes and a possible 10% penalty. The Solo 401(k) is available to any business that employs only owners and their spouses, including C corporations, S corporations, partnerships, and sole proprietors working part-time or full-time in their businesses. The Solo 401(k) is not suitable for businesses with employees, or those that plan to hire employees.

To withdraw from your 401(k) is an important decision that can deplete a large part of your retirement nest egg if you are not careful. A 401(k) loan should be used only for those times when you absolutely need the money and you are certain that you will be able to repay the loan to your 401(k) account.

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Daniel Lamaute of Lamaute Capital, Inc., (InvestSafe.com) is retirement plans expert. Visit www.investsafe.com to learn about methods to maximize retirement contributions and to reduce taxes and penalties on early withdrawals. Lamaute Capital, Inc. does not give legal or tax advice. Tax laws and regulations are complex and subject to change. Please consult an attorney or tax advisor for tax advice.