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Chapter 17. Borrowing from Yourself > What If I Can't Pay It Back? - Pg. 171

Borrowing from Yourself 171 And don't forget the interest rate. Plans must charge the current market rate, equivalent to what you would be charged at that local bank. No sweetheart deals here, even if it is your own money. The whole transaction must be considered at arm's length, meaning it would pass muster with the DOL as being legit. The interest rate is usually one or two percentage points above the prime rate (the loan rate available to a bank's best customer). This rate is fixed over the life of your loan, but could change for future loans due to changes in the prime rate. Most companies make it easy for you to pay back the loan by doing payroll deductions, so you'll get your loan paid off on time. If they don't do payroll deductions, you'll be required to make at least quarterly payments to the plan trustee. The interest that you're paying will go right into your 401(k) account along with the amount you're paying back each paycheck. And because of that, the guys in Washington won't let you have your cake and eat it, too, so the interest is not deductible, even if you use it to purchase a home. What If I Can't Pay It Back? Loans usually must be paid back within five years, except for the purchase of a primary residence. Then you may get a bit of slack; you may have 10 to 25 years to pay off the loan, depending upon the generosity of the plan. You've taken out a loan, and everything in life is going smoothly. Right! As we know, there is always a pothole in the road, and here comes yours. You lose your job or, worse yet, you quit. Now what do you do with that outstanding loan from your 401(k)? You may think it's your money and you're right, it is ... but. "But" is a little word that usually gets us into big trouble. So here it is. You made an agreement with those Washington guys that you would put money into your 401(k), and they would allow your money to go in pre-tax, and it would compound tax-deferred until you start to withdraw the funds in retirement. Remember that agreement that you signed when you started