The bills keep coming every month. You might be overextended due to a job loss or unforeseen medical expenses. Or you might want to open a business or send your child to college.
You then receive a different statement, showing the balance in your 401(k). Tempting. You’ve heard you can borrow from your 401(k) for certain things, repaying the loan through payroll deductions. But you’re not sure if it’s a good idea.
First, you’ll need to find out if your employer’s 401(k) retirement plan even allows loans and for what purpose. Some plans allow loans for specific expenses and some do not allow loans at all.
If you’re allowed to take a loan on your 401(k) plan, you might want to check out the 401(k) loan calculator. This calculator shows you how much you stand to lose in compounded earnings if you pay your loan on time, and it shows you how much you face in additional taxes and penalties if you don’t repay your loan. Either way, you potentially lose out. A 401(k) borrower who loses his or her job before repaying the loan will have to pay in full immediately or within a short time frame. Alternatively, the loan would be considered a distribution, and taxes plus penalty would be due for the relevant tax year.
When considering the benefits and the risks associated with taking out a loan against your 401(k), you should also consider whether you’re allowed to borrow the full amount needed. Typically, there is a limit to how much of your 401(k) assets can be borrowed. Most financial experts do not recommend borrowing from your 401(k) to pay off debt, for example, especially if you cannot eliminate all or a significant portion of the debt.
Borrowing from a 401(k) may seem like an easier solution than borrowing from another source, but once you consider all the consequences — including a possible shortfall for your retirement needs — you may change your mind.