Borrowing From Your 401(K) Plan

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Borrowing from Your 401(k) Plan

Investments and services offered through Morgan Stanley Smith Barney LLC, and accounts carried by Morgan Stanley & Co. Incorporated; members SIPC.© 2009 Morgan Stanley Smith Barney

Tom Kokjohn, CFP

Financial Advisor

GP08-04379P-N12/08 – July 2009 [Expiration Date]

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Y:\Other\Get the Most Out of Your IRA (5936612) 04/11/23

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Why Are We Here Today?

Review how a loan from a 401(k) works

Examine the potential advantages and downsides of a loan from a 401(k)

Discuss factors that you will need to consider before deciding to take a loan from your 401(k) plan

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Why Borrow from a 401(k)?

Individuals borrow from their 401(k) plan when there is a real need and when other sources of funds are not readily available or are too costly.

They also borrow from their plan to: Pay for college tuition Cover uninsured medical expenses Fund the purchase of a primary residence Prevent being evicted or defaulting on a mortgage

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What Is a 401(k) Loan?

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Principal & interestpayments

Loan amount

401(k)Plan

401(k) Loan

Loan amount

Principal & interestpayments

Traditional Loan

Bank or Bank or other other

creditorcreditor

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How Much Can I Borrow?

Minimum account balance

Minimum loan amount

Maximum loan amount, greater of:

100% of vested balance up to $10,000

50% of vested balance up to $50,000

Adjustment for multiple loans Maximum loan amount less the

highest outstanding loan balance within the preceding 12 months

Account Balance Maximum Loan

$0 – to Minimum Balance $0

Minimum Balance – $19,999

100% of Account Balance up to $10,000

$20,000 – $100,00050% of Account Balance

Over $100,000 $50,000

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How Much Can I Borrow? – Example

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Vested BalanceHighest Loan Balance

in Past 12 monthsMaximum Loan

Amount

$60,000 $0 $30,000

Vested BalanceHighest Loan Balance

in Past 12 monthsMaximum Loan

Amount

$50,000 $9,000 $16,000

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Terms of the Loan

Fees

Interest rate

Repayment period

Payroll deduction

Early repayment

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Tax Treatment

No taxes or penalties on loan amount

After-tax payments

Interest not tax-deductible

Repayments taxable as ordinary income upon withdrawal

Taxable as distribution upon default

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Tax Treatment – After-Tax Payments

Principal payments

Interest payments

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Advantages

Convenience

Low rates

Interest paid to yourself

Ability to select source of funds

Longer repayment period for home loans

Simplicity

Early repayment

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Downsides

Availability

Opportunity cost

Temptation to reduce contributions

Loan default

Required repayment if you leave employment

Fees

Interest not tax deductible

Repayment restrictions

Spousal consent

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What Happens if I Default?

Default on Outstanding LoanBalance of $20,000

Federal income tax (28%) $5,600

State income tax (5%) $1,000

10% early withdrawal penalty $2,000

Total Taxes and Penalties $8,600

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Impact on Retirement Goals

Opportunity cost

Choosing the source of funds

Importance of continuing contributions

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Example – No Loan with Continued Contributions

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Starting Balance $40,000

Annual Contributions $5,400

Ending Balance after 30 Years $1,040,432

Hypothetical example

Assumes 8% annual rate of return

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Example – Loan with No Contributions during Repayment


Loan Amount $20,000

Annual Loan Payments (5 Years) $4,529

Annual Contributions during Repayment Period $0

Annual Contributions after Repayment Period $5,400

Ending Balance after 30 Years $802,688

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Example – Loan with Continued Contributions during Repayment


Loan Amount $20,000

Annual Loan Payments (5 Years) $4,529

Annual Contributions during Repayment Period $5,400

Annual Contributions after Repayment Period $5,400

Ending Balance after 30 Years $1,028,936

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Example – Comparison

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0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30

Years

No loan with continued contributions

Loan with no contributions during repayment

Loan with full contributions during repayment

$1,040,432

$802,688

$1,028,936



$0

$200,000

$400,000

$600,000

$800,000

$1,000,000

$1,200,000

Acc

ou

nt

Ba

lan

ce

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Should I Borrow from My 401(k) Plan?

How important is your need for the loan?

Can you obtain the needed funds from other sources?

Are you planning to leave your job within the next few years?

Is there a chance you will lose your job due to a company restructuring?

Will you be able to continue to make regular contributions to your plan?

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Your Financial Advisor Team at Morgan Stanley Smith Barney

Our Financial Advisors can provide:

Access to intellectual strength and global resources of Morgan Stanley Smith Barney

Financial solutions that address your specific needs and goals

Tom Kokjohn, CFPFinancial Advisor

858-618-7930 [email protected]

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Morgan Stanley Smith Barney, Morgan Stanley & Co. Incorporated and Morgan Stanley Smith Barney’s Financial Advisors do not provide tax or legal advice, are not “fiduciaries” (under ERISA, the Internal Revenue Code or otherwise) with respect to the services or activities described herein, and this material was not intended or written to be used for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Individuals are urged to consult their tax or legal advisor before establishing a retirement plan or to understand the tax, ERISA and related consequences of any investments made under such plan.

Borrowing From Your 401(K) Plan

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