Understanding 401k loan interest as well as the fees you will be paying should be a crucial part of your decision as to whether or not you are going to take a loan from your 401k. You want to know this information much the same way as you would want to know the rates and fees from a bank.
Yes, on a 401k loan you do pay interest. But the upside here is that you do not pay the interest to your bank or even your 401k provider. Rather, you pay the interest back into your own account -all of it. This is certainly an advantage over taking a loan from a bank (at least on the surface).
The 401k loan interest rate you pay varies from plan to plan, but it is quite common for plans to charge 1% over the federal prime rate. So, if prime is sitting at 6%, your loan interest rate will be 7%.
We’ve also seen plans that charge a flat percentage regardless of what the prime rate is. And these plans usually set the rates fairly high – sometimes 9 or 10%. These plans reason that they set the rates so high so the loan has less of a negative impact on the participant since they are paying themselves back so much more than at the usually lower rates. There is no right or wrong when it comes to interest rates. The plan is simply required to justify its decision if the need ever arises.
Fees are a slightly different story. Any fees that you are required to pay for taking a loan usually go to the 401k provider for the cost to administer the loan, not back into your account. Sorry!
There are generally two types of fees that must be paid: a loan issuance fee and an annual administrative fee. The costs of these fees vary greatly from plan to plan. Each can cost anywhere from a few dollars to a hundred dollars.
As a plan participant, the amount you pay in fees depends on a)how much the 401k provider charges for the fee itself, and b)whether your employer helps pay for any of it or not.
In some cases your employer might pick up the entire tab. You’re certainly lucky if you don’t have to pay any fees. Other employers may pick up only a portion of it, or none at all.
Consider everything-401k loan interest and fees-before forging ahead and digging into your retirement account for some extra money. A little thought goes a long way!