Financial Literacy - Smart borrowing
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Need cash? There's your 401(k) ...

A downside to using 401(k) funds: The interest you pay to yourself is not tax deductible. Interest paid on mortgages, home equity or student loans generally does qualify as a tax deduction.

3. Temporary loan. Most loans are repaid over five years, though a large loan used to buy a primary residence generally can be repaid over 20 years.

Borrowers who repay their loans run the risk of suspending their regular retirement contributions. So not only is the borrowed money not invested in the market; borrowers may not be adding any more contributions as long as they are repaying the loan.

"It could be a slippery slope because the repayments do come out of your paycheck, which lowers your take-home pay," says Fik.

Adding regular contributions to the loan payment would further reduce it.

If the borrower has extra money to pay back a loan and make new contributions, he or she probably would not have taken a loan in the first place, he says.

4. No credit repercussions. Borrowing from yourself might seem particularly advantageous for consumers with poor credit, but if your job is in jeopardy or you believe you may change jobs in the near future, taking a loan can be costly.

If you lose your job or move on to new employment, the outstanding loan usually becomes due within 60 days. If you don't pay it, after that time it becomes a distribution and will be subject to income tax and the 10 percent early withdrawal penalty.

401(k) debit cards

Legislators are concerned about the ease with which Americans can put their retirements at risk by taking out loans. Add to this a relatively new feature for some 401(k) plans: the 401(k) debit card.

A bill recently introduced in the Senate would limit the number of loans an individual can take from their 401(k) accounts to three and ban the use of 401(k) debit cards, currently offered by only one company. The Securities and Exchange Commission and the Financial Industry Regulatory Authority have issued warnings to investors about their use.

Lawmakers should restrict access to 401(k) loans, says Christian E. Weller, Ph.D., senior fellow at the Center for American Progress, an associate professor of public policy at the University of Massachusetts Boston and co-author of the earlier mentioned study on 401(k) loans.

"I know some economists who go even as far as saying you should completely ban loan access," he says.


Such extreme measures may not be necessary. Weller's own research shows that Americans generally don't enter into the decision lightly, tapping into their 401(k)s only when under financial duress.

"Among the group of people who have access to these loans, we find that it is people who are already financially strapped who need to pay for economic necessities. They need to cover a spell of unemployment of a family member or they need to pay for medical care or they need to buy a house. They're not going out on shopping sprees," he says.

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