But first let’s talk about some reasons that you may want to borrow. Let’s say you want a new boat, or maybe a plasma TV. Don’t even think about it. Your future is much more important than the pleasure that you may get from those items. But let’s say you are renting a house and a great buy on a dream house comes on the market. You know that you will be walking away from the table with equity. You and your spouse have secure jobs and plenty of savings, and you are on a solid financial plan. But you don’t have the down payment required to get the house. In this case I would say that it is a no brainer. Jump on it. Buying a house is normally a great investment. You will be buying a future for yourself instead of someone else. When you rent, you are actually paying for someone else’s house and you leave with nothing.

Let’s think about what is actually happening here. You are borrowing money from yourself and paying yourself interest. Better than paying a bank, if you were going to do it anyway. Let’s say that you were earning 11% and your rate was 9%. You would be earning 2% less, plus you would be losing the tax advantage. Doesn’t seem like much now, but it could be a huge amount at the end when you retire. Of course if you end up with a free and clear, mortgage free home because of it, than I would say that you made a very wise decision.

Plans vary some so check with your employer before you make any serious commitments. Normally you have 5 years to pay back the loan. If you used it for a new home purchase you may have up to 30 years to pay it back, but some plans limit it to 10 years. Rates are competitive and could be around the prime plus 1%. Normally you can borrow up to $50,000 or half of what you have in the plan, which ever is smaller.

Let’s look at the good. The loans are normally quick. You don’t have to qualify (except to yourself!). The interest rate is usually quite competitive, plus you are paying it to yourself. If you took the money out instead of borrowing, you would have paid a 10% penalty for early withdrawal.

And the bad. You are slowing down the growth of your retirement fund. Some plans do not let you make contributions while you are paying it back. Ouch.

And the ugly. If you leave your job, you will have 60 days to pay the loan back. If you couldn’t you would have to pay the 10% early withdrawal penalty plus taxes on the whole amount. Double ouch!

So what is the answer? I would say that it is rarely a good idea. I have shown a scenario where it would be a good idea, but all situations are different. Only you can decide if it is a good plan for you. So if borrowing against your 401K can make you a nice investment for your future, or get you through an emergency, it may be an alternative to consider. Do your research and ask a lot of questions before making the decision. It will have an affect on your future!

So just what is the maximum contribution that you can put into your 401K account? It depends on the government guidelines, your salary, and your plan. Your contribution limit is the lower of the maximum amount that your employer allows as a percentage of your pay or the government maximum allowed amount. The maximum government amount for 2008 was $15,500 and for 2009 it is $16,500.

That was a little confusing so let’s do an example. Your employer allows a 10% contribution and you made $50,000. You would only be allowed to contribute $5,000.  Obviously the $16,500 maximum is for higher paid employess.

401K Maximum Contribution Exceptions

If you are at least 50 years old you may be eligible for “catch-up contributions” if your employer allows. The 2008 maximum for this was $5,000 and $5,500 for 2009.

If yor employer matches contributions they are not counted towards your 401K maximum contributions, up to 6%.

401K Maximum Contribution: Why should you do it?

Why in the world some people don’t do this, I will never know. Let’s take a look at a scenario. I will try to keep it simple and easy to understand. Let’s say that you contribute $100 to your 401K plan. Let’s assume that you are in the 25% tax rate. Right away it only cost you $75 to put that $100 away, because it was pretax money. So it was exempt from those taxes. So we will say that you made 25% interest. Wow, not bad. Now let’s assume that you made a good choice for your investment vehicle and you made 10%. Ummm, up to 35%. Now let’s assume that you are in an employer matching 401K plan. That $100 turned into $200, plus another 10% interest earned on that money. Looks like an extra 110% earned. Is that 145% interest? Well there are other considerations. You will have to pay taxes on that money. But it will be when you are retired and in a much lower tax bracket. And you will have used that money to earn money.

This was a very rough scenario, and these numbers may not be exactly correct, but they will make you think of what you are giving up! Where I worked the employer only matched 3%, but hey, that is a 3% raise in my eyes. AND WE HAD PEOPLE WHO WERE NOT IN THE PLAN! To me that is like your employer trying to give you a 3% raise (actually more if you consider the other benefits) and you are saying “no thanks”.

Everyone needs to put some money away for the future. The 401K is a great vehicle for doing that. You put the money away before you see it. Most of the time you will not miss it. And maybe you don’t feel comfortable with the maximum contribution right away, but get started. You can aways increase your contribution later. The most important thing is to get started!