7 Reasons not to Borrow from your 401(k)

Posted on September 6, 2018 by in Retirement Planning

Can you think of any reasons not to borrow from your 401(k)?

Having a traditional retirement savings plan in place often triggers the temptation to borrow from it.

After all, it’s your money!

Before making any financial mistakes though, consider that taking a loan against your retirement savings generally has long term consequences.

In theory, borrowing from a 401(k) may make sense.

First, the interest rate you’d have to pay is lower than the one a commercial lender charges.

Second, you’d be repaying the loan, with interest, to yourself.

However, borrowing from a 401(k) ‘for real’ is almost never a good idea.

Reasons not to borrow from your 401(k)

You’re putting saving for retirement on a long hold

Most 401(k) plans don’t allow you to continue making money contributions until your balance is paid off.

Other retirement savings plans may allow you to continue making additional contributions, but that doesn’t make much sense, since you have the 401(k) debt to pay off as well.

In other words, until you pay off the loan you took out from your 401(k) plan, you’re likely to put retirement savings on hold for a while.

Is that really worth it?

You’re leaving money on the table

You might justify taking out a loan with an extremely low interest rate, but say goodbye to compound interest earnings!

When you take money out of your retirement savings, you’re selling part of your investments.

If the stock or bond markets grow, you are literally losing money.

Since you took out a large portion of your contributions, you no longer benefit from the same compound interest benefits!

Your money will be taxed twice

You may be thrilled to pay a lower interest rate on a 401(k) loan, but your money will actually be taxed twice!

First of all, you’re paying back the loan with after tax money.

Second, the same money will be taxed again, when you’ll retire and start withdrawing from your retirement plan.

Your retirement nest egg will be significantly reduced

Contributing to your 401(k) has its limits.

If you think you can take out a loan, pay it back fast (with interest) and continue with your retirement savings where you left off, you’re probably wrong.

As mentioned before, some 401(k) plans do allow you to make contributions, in addition to the repayment of the loan.

However, maxing out your 401(k) while also paying off your balance is highly unlikely!

As a consequence, you’re shrinking your retirement nest egg significantly by borrowing against it.

You’ll have to hold on to your job for deal life

Generally, you have 5 years to pay the 401(k) loan back.

Quitting your job, however, requires you pay off the loan over the next 2 months!

How is that even possible?

While many are able to either meet the term or even pay the balance off earlier, that’s still a lot of time to be ‘stuck’ with your job!

Whether you want to quit because you ‘hate it there’ or because you found a new, better paying job, you’d still have to fork out the money somehow, if you don’t want to get in trouble with the IRS!

You’ll get in trouble for failing to meet the deadline

5 years seems reasonable enough to pay off a loan you took from yourself, right?

Failing to comply though leads to serious financial consequences!

First off, you’ll likely have to pay a 10% early withdrawal penalty, if you’re under 59 1/2.

Also, the outstanding loan balance will become subject to income taxes.

In addition to being in debt, you’ll have even more taxes and penalty fees to pay!

Taking out a 401(k) loan is still debt

Borrowing against your own personal retirement plan is very similar to borrowing from a commercial lender!

You’re still in debt and, as previously mentioned, not paying the loan off in time comes with consequences.

A 401(k) shouldn’t be considered a source of easy money.

Borrowing against it is allowed, but definitely not recommended.

Have you ever borrowed money from your 401(k)? How did it work out for you?

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