Your Money: Should I Tap My 401(k) to Pay Off Debts?

RISMEDIA, Jan. 21, 2008-(MCT)- Q: My wages haven’t really kept up to increases in my expenses in the last year. I’ve racked up a large amount of credit card debt and I’m thinking about taking a loan against my 401(k) to pay off my debts. Will I regret this later?

A: Most employer-sponsored 401(k) plans allow you to take out a loan. But there are certain rules and if you don’t follow them, you’ll be penalized, says Peter Eckerline, senior vice president of investments in Merrill Lynch’s Wayzata, Minnesota office.

You can take out 50% of the vested account balance but you must repay the loan with interest within five years unless you’re taking the loan for a home down payment — in which case you have more time. Interest rates vary but typically interest is based on the prime lending rate plus 1 percentage point. You pay that amount back to yourself. So if you have a vested balance of $10,000 in your account, you can borrow up to $5,000 with a plan to pay it back. Perhaps you’re paying 14% on your credit card debt. If your investments are not growing faster than that, taking a loan to pay down debt is one option, Eckerline says. But if you fail to pay it back, it will count as a distribution and you’ll have to pay a 10% penalty and the amount you tapped will be taxed as income.

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