5 Reasons Not to Borrow from Your 401k
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A 401k Loan?
Times are tough for some. But are they tough enough to resort to borrowing from your 401k? Does a job loss warrant this kind of move? I guess, like all personal finance, it really depends on your particular situation.
Still, generally speaking, the 401k should likely not be looked at as a normal, everyday way of financing a lifestyle that’s above your normal means. This means no borrowing to buy a boat, new TV, or for a home improvement. If you want those things, it would be wiser to just save up the money in a savings account.
Need some convincing? Here’s a few reasons not to borrow from your 401k:
It’s For Your Retirement
The whole reason you set this account up to begin with was to save money for your retirement. If you’re not retired yet, just leave this money alone. Had you set some money aside to borrow from at a later point, I’d say go ahead. But this is your 401k. Just leave the money, and your original intentions alone.
It Won’t Be There For a Real Emergency
If you yank that money from the 401k now using a loan option to finance some frivolous purchase, and then everything hits the fan, you’re left in a tough spot. Leave that money alone and save the loan option as a extreme last resort.
The Borrowed Money is Not Growing
Money that isn’t in the 401k account (the borrowed amount) can no longer see investment growth. It’s gotta be there to be earning for your retirement. This is long-term investing we’re dealing with here. Letting it ride is key. Moving money in and out defeats the purpose.
The Loan is Tied to Your Job
This is one of the more obvious reasons for staying away from the 401k loan. If you leave your job for any reason, most companies will require you to pay that loan back at a much faster rate, or even immediately. You don’t want to be stuck holding this loan if you get canned. Remember, you borrowed because you didn’t have enough money to begin with. So what makes you think you’ll be able to pay it back quickly?
Fees and Contributions Limits
Some company plans require that you stop contributing to your 401k once you borrow from it. Also, some plans tack on fees to the loan payments. These are definitely things you want to avoid.
My Experience
I was tempted to borrow from my 401k a couple of years back when we were saving up for our first home down payment. I was worried we would need a small 401k loan to get us over the 20% mark. The option to borrow was definitely very enticing. But in the end, I decided to leave the money alone. And you know, we ended up being able to save the 20% anyway by working a bit harder at spending less.
So what’s your take…should you borrow from your 401k?
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13 Responses to “5 Reasons Not to Borrow from Your 401k”
By Bob at Dollar And Dollar on Mar 24, 2009 | Reply
Retirement accounts are intended for post retirement. i agree with all your reasons not to take loan from 401k account.
By bank deals on Mar 24, 2009 | Reply
If I take out a loan against my 401k will it affect my credit rating?
I’m thinking of buying a home and wanted to consolidate some bills beforehand and was wondering if this would have any neg affects.
By FFB on Mar 24, 2009 | Reply
Also, you put money into a 401(k) before taxes. If you take a loan you pay it back after taxes! In essence it takes more money to pay it back.
By Sandy on Mar 24, 2009 | Reply
Let me speak from the experience of someone who HAS borrowed from my 401K.
1. I borrowed from my 401K at 28 so I knew that I had quite a lot of time to repay the money. The loss in potential interest did not bother me too much. I also made sure that the repayment period was as short as I could afford it to be. I did not want to extend it.
2. I made the interest rate as high as the return that I had been getting on my money. Thankfully I borrowed the money right before the recent crash so I actually ended up preserving some of my money since my portfolio lost 35% last year.
3. I was in dire need on the money and had no other place to come up with the large amount of cash that I needed in such a short amount of time with an affordable interest rate. I would not recommend borrowing money to purchase a car or finance education or something like that but if it comes down to borrowing against the 401K and being out on the street then I am all for tapping that cash.
Everyone has different situations but you should be fully aware of what you are getting into. Know that you have to repay immediately if you separate from your job. Know that you have to pay both penalties and interest if you do not repay. Things like that could make you pause. Know that the loan is paid back with AFTER tax money.
I did what was right for me at the time and in 8 months or 16 payments from now I will be free of the 401K loan, freeing up a full $400 per month to smash my other debt. It also taught me how to live on $400 LESS per month while still contributing 6% of my pretax income to my 401K so I will nor return to my old ways.
By seeabell on Mar 24, 2009 | Reply
I know, I know, I’m a prime offender of borrowing against my 401K. But the reality right now is the money I’ve borrowed is the only piece of my 401K that isn’t dropping like a rock. In addition, the money going back as an after tax payment doesn’t bother me at all, because if I borrowed from a bank, it would have been paid back after tax as well. I get the interest. Something my 401K is not providing at the moment. If anything, I sold high and bought low. So I’m not finding this argument as convincing in the current market. I should note that I am paying back the amount, so the money will still be there in 20+ years when I retire. I’m sure I’m missing something, what is it?
By Sandy on Mar 24, 2009 | Reply
@bank
No, it doesn’t show up on your credit report but the bank will see it as a reduction in your income since they will see your pay stubs.
By PT on Mar 24, 2009 | Reply
@seeabell
I definitely agree that the negative effects are lessened a bit since the market has been dropping over your borrowing period. Still, some things to think about:
1. What if you got let go from work? Something more probable these days. Would you be able to pay it back at the terms your company has set forth? Do you know those terms?
2. What if the market hadn’t dropped over the last 6 months like it had? What if it goes back up to 10,000 in the next few weeks? Your investments wouldn’t grow like they could have. Possible? Who knows? Timing the market isn’t something anyone’s been able to do successfully over 20 yrs to my knowledge. I think you just got lucky in that regard. Unless you know something I don’t.
Both reasons point to the 401k loan being a `fundamentally` poor choice in most situations. I don’t know why you pulled the money out, but if you’re like Sandy, it may have been a last ditch effort to save things. In that sense, I definitely not going to sit here and judge you for your actions. Good luck to you and thanks for sharing.
By TStrump on Mar 24, 2009 | Reply
I’ve been looking at my account recently and it’s been tempting, especially since I’d like to get out of my job right now.
But, I will stay the course and not withdraw anything.
By Rob on Jul 6, 2009 | Reply
My stock has fallen more than 50% but I am with a fairly safe company (GE). Is it a decent decision to borrow from my 401k now while the stock is low? I know if the stock starts shooting up I lose the gain right away but I really dont think that is gonna happen for atleast another 2 years. Also I talked to a company rep and he said if I did leave the company that I could still payback the loan on a monthly basis without a penalty from the IRS. Is this true? Everything I have read makes it sound like this is a Law and the company has no say in it? Any help?
By PT on Jul 6, 2009 | Reply
@Rob – I can’t find anywhere in the IRS regs where there is a set payback period upon termination. That being said, if your company allows a longer pay back period, even after termnination, I think it’s safe to say you’ll have that long to pay it back without tax consequence.
All that being said, I think borrowing from the 401k should be your very last option, regardless of market conditions or assumptions.