Many people think of their retirement accounts simply as harder-to-access extensions of their savings or checking. So when they’re in a financial bind, they don’t really think twice about using their 401(k). They think, “It’s my money. I can do what I want with it.” That may be true, but there are some repercussions to doing “what you want with it.”
Being in debt is an overwhelming feeling. All you can think about it paying it off and getting the debt collectors off your back. Borrowing from your 401(k) isn’t the way to do it. Here’s why you shouldn’t take out a 401(k) loan.
1. You'll still have debt
Let’s say you use a 401(k) loan to pay off your debt. You’ve eliminated one debt and now you have another. The only thing you’ve changed is who you owe and maybe your interest rate. If this were the only drawback to borrowing from your 401(k), the benefit of a lower interest rate might be worth it. But, there are other risks and reasons that this solution unwise.2. Your take home pay will be lower
You’ll repay your 401(k) loan through payroll deductions so your paychecks will end up being lower, putting more pressure on your budget. This can make a bad situation worse if you’re already having trouble making ends meet.3. Leaving your job will be expensive
If you leave your job, you’ll have to repay what you borrowed from your 401(k) within 60 days or face early withdrawal penalties and income taxes. If you withdraw from your 401(k) before you turn 59 1/2 you face a 10% penalty. That’s $2,000 on a $20,000 loan. That $20,000 will also be added to your taxable income and taxed an additional 10% penalty.4. Your retirement savings will be put on hold
Borrowing from your 401(k) reduces your overall retirement potential. You won’t be able to contribute to your 401(k) until the loan has been repaid. So if you typically put in $500 a month and it takes you 2 years to repay your loan, you’ve missed out on $12,000 in contributions. Not only do you miss the contributions, you miss the interest earnings you would have gained on what you borrowed and what you would have contributed.5. You could end up in a higher tax bracket
If you were maxing out your 401(k) contributions to put you in a lower tax bracket, you won’t receive that benefit after you take out a 401(k) loan. Your payments to the loan are taken out post-tax and you can’t claim them as a deduction on your tax return.
