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Loan Consequences

If your company offers a 401(k) plan loan, it can be among your most cost-effective options for short-term needs (five or fewer years). However, these loans come with potential drawbacks. Before you take money from your 401(k), understand all the consequences.

THE BASICS

Not every 401(k) plan will allow loans, but the majority that do will have limits — typically no more than 50% of an account balance. Loans are potentially better for your bottom line than withdrawals, because doing the latter could trigger early withdrawal penalties.

Still, a 401(k) loan could be better than the alternatives, with potentially lower interest rates and automatic deduction of loan payments from your paycheck. Additionally, it won’t require a credit check.

However, a 401(k) loan can cause some unintended consequences outlined below.

DRAWBACKS

One drawback is two-pronged: The amount of your loan will miss out on potential growth, while your paycheck will be lighter by the amount of your repayment until the loan is paid in full. The second drawback is more problematic. Whether you lose your job or leave it voluntarily, you will still have to repay the loan.

Many plans will require payment in full before you separate from employment. If you don’t have the money to pay the entire loan, your plan administrator will deduct the amount from your account balance. This will create tax problems, as the IRS will see this repayment as a distribution with accompanying early withdrawal penalties and income tax due.

Discuss with your financial and tax professionals whether any loan is a necessity, as well as other alternatives, before you take a 401(k) plan loan. Be sure to consider how this or any loan may affect your long-term savings strategy.

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Beware of Tax Scams

Don’t fall victim to scams during this tax filing season. Recognize these red flags.

The IRS doesn’t initiate contact with taxpayers or request personal or financial information through phone, email, text message or social media. You’ll usually receive several letters from the IRS before an agent calls you or comes to your home or business.

Also, the IRS doesn’t call to demand immediate payment using a specific method, like gift cards or wire transfers. Any tax payments should be made directly to the United States Treasury.

IRS personnel will never threaten to send local police or immigration officers to arrest you if you don’t pay.

If you’re ever in doubt about the legitimacy of messages or letters you receive, contact your tax professional right away, or call the IRS.

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The Benefits of Financial and Tax Strategies

A well-coordinated financial strategy encompasses more than just your investments. It considers every aspect of your finances, from budgeting to retirement saving, to ensure you’re making decisions that can help you reach all your goals.

THE BIG PICTURE

A successful strategy should provide a complete view of all your finances. By knowing how much savings you have accrued and the debts you owe, you can come up with a roadmap for spending, saving and investing. Identifying your short- and long-term goals is a good place to start. Paying off debt might be a short-term goal, while saving for retirement generally is a long-term goal that could be years in the future. Setting aside money for a child’s education might be a mid-term goal.

WORK TOWARD YOUR GOALS

A cornerstone of your strategy should be the probability of reaching all the milestones you’ve identified. You and your financial professional choose a target asset allocation based on your goals, time frame and risk tolerance. Whether you’re an aggressive or a conservative investor, it’s essential to periodically check your progress toward your goals and adjust your strategy as needed.

YOUR RETIREMENT PICTURE

What you want to do in retirement can be a factor in how much savings you’ll need to accumulate. If you plan to travel, relocate or even start your own business, you’ll need to have sufficient funds for those endeavors. Your financial professional can help you estimate your future financial needs and build the wealth you’ll need to meet them.

MARKET UPS AND DOWNS

Periods of market volatility and high inflation can affect your investments’ performance over the short term. Investors may panic and sell investments when values are down. Historically, markets have always recovered their losses. Your financial professional can help you make investment decisions that aren’t driven by short-term market fluctuations.

HELP WITH TAXES

Taxes can impact your finances both before and during retirement. A tax professional can help you create a tax-efficient estate plan, advise you on charitable donations and explain any tax breaks and deductions that are available to you.