With the covid relief packages many advantageous rules were put into place for people to use with their 401(k) funds.
The next stimulus that is on the verge of going into law has refreshed people's minds on this, thus it is a good time to review some points I talked about earlier this year.
Mistakes to Avoid with Your 401(k) Funds
TAKING 401(K) LOANS FOR THE WRONG REASONS
In difficult times tapping your 401(k) through a loan may seem like a decent idea. It is access to funds at a relatively low interest rate after all. The issue here is the pay back. As discussed earlier this loan requires interest payments and full repayment in five years otherwise taxes and penalties are incurred.
Sometimes circumstances dictate and you do not have a choice. It is the leisure and desire for things that I am referencing here. For example, taking a 401(k) loan to pay for a dream vacation is not very prudent. Not only are you turning an asset into an expense, you are also losing out on the compound growth of those funds over the next five years while the loan is paid back.
MISSING ROLLOVER DEADLINES
IRAs are a popular destination for extra or old 401(k) money. Some companies require you to transfer funds the moment you are no longer employed while others will let you keep your money in their plan, indefinitely.
Rollovers can be direct or non-direct, from one employers plan to the next. Direct rollovers generally require no effort other than signing the requisite paperwork and no taxation is incurred. The funds are transferred directly from your old 401(k) to the new retirement account. On occasion, a plan administrator will not be able to perform a direct transaction.
Instead a check made out to your new retirement account will be made, which you then must deposit.
Non-direct rollovers require a little more action since a check will be cut from your former 401(k) plan administrator to you, at which point you have a window to deposit those fund into a new retirement account to avoid taxation and/or penalties.
The 60-day rollover rule is the most important thing to remember. This is where people run into trouble, that window gives the opportunity to get creative. Since the funds have been made out to you they are available to do whatever you like with over the next 60 days, theoretically speaking. Whether using the money for short-term needs or a short-term investment you are putting your retirement funds at risk.
The plan may be to use the funds on something else and have them back in time to meet the deadline, but if something goes awry and you cannot deposit the funds into your new retirement account they immediately become taxable income and if you are under the 59 ½ age limit the 10% penalty is triggered as well.
Though it may be tempting to use these funds, the risk vs. reward may not be worth the gamble.
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