Why Is It A Bad Idea to Take a Loan from My 401(k)?

Why Is It A Bad Idea to Take a Loan from My 401(k)?

Generally, it’s a really bad idea to take a loan from your 401(k).

Wealth Advisor’s recent article, “Why You Shouldn’t Take A 401(k) Loan,” lists some of the reasons why.

Many people who borrow from their 401(k)s wind up lowering or completely stopping their contributions, while they’re paying back the loans. This can mean the loss of 401(k) matching contributions, when their contribution rates fall below the maximum matched percentage.

Most people thinking about changing jobs don’t know that their outstanding 401(k) loan balance becomes due, when they leave their employer. Whether a job change is voluntary or involuntary, who among us has the financial resources available to pay back a 401(k) loan right away, if we leave our employer? As a result, many individual default.

However, the new tax law gives a little cushion, and you have until your tax return due date the next year. Plan balances that leave 401(k) plans due to loan defaults are rarely ever made up. That makes it less likely that loan defaulters will build sufficient retirement savings.

When you take a loan, it becomes one of your investments in your 401(k) plan account. If you were to take a $10,000 loan for five years at a 6% interest rate, that portion of your 401(k) balance will earn a 6% return for five years.

However, if your loan balance had been invested in one of the other investment options in your plan, you may have earned a lot more. Instead, look into taking a home equity loan first, because interest on those loans is tax-deductible.

Easy availability of a 401(k) loan can frequently make a bad financial situation worse. It can push you into bankruptcy and/or resulting in the loss of your home.

It is clear that 401(k) loans can significantly reduce your chances of achieving retirement preparedness.  It is also one of the worst investments you can make in your 401(k) account.

Reference: Wealth Advisor (February 4, 2019) “Why You Shouldn’t Take A 401(k) Loan”