8 Reasons To Never Borrow From Your 401(k)


Pundits claim that your 401(k) balance is a less expensive way to borrow money because the interest rate charged is generally lower than the rates on a commercial loan. They also cite the fact that when you repay the loan, you are paying yourself back with interest, instead of paying a bank. Despite these claims, borrowing from your 401(k) goes against almost every time-tested principal of long-term investing. Here we look at eight major reasons why borrowing from your 401(k) is a bad idea.

1. You Are Not Saving

If you borrow money from your 401(k) plan, most plans have a provision that prohibits you from making additional contributions until the loan balance is repaid. Even if your plan doesn't have this provision, it is unlikely that you can afford to make future contributions in addition to servicing the loan payment. Because the whole point of having a 401(k) plan is to use it is as a way to save for the future, you are defeating the purpose of having this account if you use it before you retire.

2. You Are Losing Money

If you not are not making contributions, not only is the entire balance that you borrowed missing out on any potential growth in the stock or bond markets, but each future contribution that you are unable to make (since you have a loan outstanding) isn't growing either. The extraordinarily low interest rate that you are paying to yourself with your loan payment is likely to be a pittance in terms of return on investment when compared to the market appreciation that you are missing.

3. Time Will Work Against You

Long-term investing (such as saving for retirement) is based on the idea that by putting time to work on your behalf, your money will grow. Most calculations suggest that your money will double, on average, every eight years. 401(k) plans permit each loan to be held for up to five years or longer. Therefore, if the loan is used to fund a first-time home purchase, loan holders not only lose out on what should have been an opportunity to nearly double their money, but they are also left unable to make up for the lost contribution and growth opportunities. Over time, their balance is unlikely to ever reach the total that it would have reached had contributions continued uninterrupted.

4. You Could Lose Even More Money

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 if you are under age 59.5.

5. You Are Trapped

If you have an outstanding loan, most plans require that the loan be immediately repaid if you quit your job. So, as long as you have a loan, you are stuck in your current job and may be forced to pass up a better opportunity - unless you are willing to take the loan balance as a withdrawal and pay the 10% penalty.

6. You Lose Your Cushion

Taking a loan from your 401(k) plan should only be done in the direst of circumstances after you have completely exhausted all other potential sources of funding. If you take money from your plan to fund a vacation or pay off higher interest loans, the money won't be there to borrow if you really need it.

7. It Suggests That You Are Living Beyond Your Means

The need to borrow from your savings is a red flag - a warning that you are living beyond your means. When you can't find any other way to fund your lifestyle than by taking money from your future, it's time for a serious re-evaluation of your spending habits. What purchase could possibly be so important that you are willing to put your future in jeopardy and go into debt in order to get it?

8. It Violates The Golden Rule Of Personal Finance

"Pay yourself first" is the golden rule of personal finance. This rule considered a primary tenet of good financial planning, and violating it is never a good idea.

Think First

If the idea of taking a loan from you 401(k) plan crosses you mind, stop and think before you act. Instead of short-changing your future to finance your lifestyle today, consider re-evaluating your current lifestyle instead. Scaling back on your expenses will not only reduce the burden on your wallet, but will increase the odds that a sound retirement nest egg will be waiting for you in the future.
  1. No results found.
Related Articles
  1. Financial Advisor

    401(k) Loans: The Good, the Bad and the Ugly

    Borrowing from your 401(k) is ready cash from the best possible lender: you. Here's the upside and downside to using the money before retirement.
  2. Retirement

    4 Reasons Why 401(k) Loans Pay

    Here are four reasons why you should consider a loan from your 401(k) when you have a serious short-term need.
  3. Financial Advisor

    The Pros and Cons of 401(k) Loans

    A look at the pros and cons of 401(k) loans.
  4. Retirement

    401(k) Debit Cards: Taking A Swipe At Your Retirement Savings

    This is just another more convenient way to borrow from your plan. But at what cost?
  5. Retirement

    4 Ways To Maximize Your 401(k)

    401(k) plans have become the bedrock of America’s retirement savings. Here are four steps to help your 401(k) meet your goals.
  6. Investing

    Four 401(k) Benefits You Should Take Advantage Of

    If you’re saving for retirement through your employer, there are certain 401(k) benefits that can make planning for retirement easier.
  7. Retirement

    When Paying Off Debt With Your 401(K) Makes Sense

    The experts warn against touching your retirement savings early, but there are situations where it is the best financial decision.
  8. Retirement

    Top 10 Mistakes to Avoid On Your 401(k)

    Today’s workers are most likely to depend on a 401(k) plan to fund their retirement. To help your 401(k) grow, avoid these 10 mistakes.
  9. Retirement

    401(k) vs. Picking Stocks: What's Best?

    The pros and cons of two different ways to invest your retirement savings
  10. Financial Advisor

    Your 401(k): How to Handle Market Volatility

    An in-depth look at how manage to 401(k) assets during times of market volatility.
Hot Definitions
  1. Perkins Loan

    A loan program that provides low-interest student loans to undergraduate and graduate students who demonstrate exceptional ...
  2. Wealth Management

    A high-level professional service that combines financial/investment advice, accounting/tax services, retirement planning ...
  3. Assets Under Management - AUM

    The market value of assets that an investment company manages on behalf of investors. Assets under management (AUM) is looked ...
  4. Subprime Auto Loan

    A type of auto loan approved for people with substandard credit scores or limited credit histories. There is no official ...
  5. Racketeering

    A fraudulent service built to serve a problem that wouldn't otherwise exist without the influence of the enterprise offering ...
  6. Federal Debt

    The total amount of money that the United States federal government owes to creditors. The government's creditors include ...
Trading Center