Should you borrow from your 401(k)?
Not unless you absolutely have to, and here are some reasons why:
If the loan repayment keeps you from saving, you are putting your retirement further off. If your plan has a provision that you cannot make contributions while the loan is outstanding, the 401(k) loan is really a bad idea.
1) You are losing money. The low interest rate that you are paying to yourself with your loan payment falls far short of the return on investment you would receive by contributing the funds to your 401(k). The whole idea of investing in a 401(k) is to leave it invested so that it will grow tax free until you retire.
2) Time is not on your side. The idea of a 401(k) is to keep building the amount so that, on average, it doubles every seven to eight years. If you take a loan out to, say, finance a vacation you can’t afford to pay for with cash and then you take 7 or eight years to pay it back, you are missing out on those years when your nest egg could build. You will be playing catchup after that, and you are taking a chance, because people’s incomes don’t always increase.
3) If you lose your job or you have another financial calamity, you could really lose. Should you find yourself in a position where you are unable to repay the loan, it is treated as a withdrawal and the outstanding loan balance will be subject to current income taxes in addition to a 10% early withdrawal penalty.
4) You can’t quit your job, either. Most plans require that the loan be immediately repaid if you quit your job. So you may have to keep working at a job that you feel stuck in or miss an opportunity to move to a better situation because you don’t want to pay the penalties on the unpaid loan.
5) What happens if you really have an emergency? Most financial planners suggest saving up six months worth of living expenses in case something happens that you don’t expect. if you haven’t been able to do this, but you have been contributing regularly to your 401(k), you have a cushion you can fall back on (unless you borrow it for the boat you can’t afford).
6) If you are borrowing money from your 401(k) for anything except the most catastrophic circumstances, you are living beyond your means, and we’ve all seen how that turns out (300,000 projected foreclosures per month in 2008).
So if that 4.5 percent interest rate 401(k) loan looks too good to be true (it probably is).