Borrowing from your 401(k) is generally a bad idea. There are some positive aspects of doing so, however. It’s a nice option to have if you are stuck with no other choices. Here are some of the drawbacks, as mentioned by Lewis Schiff from the Armchair Millionaire.
- The money you take out of your 401(k) for the loan will not be growing. Most people, while paying back the loan, stop making pre-tax contributions, which is a double whammy.
- Since you’re paying back the loan with after-tax money, taking distributions from that money will cause some funds to have been taxed twice.
- If you leave your job, the full amount of the loan could be due immediately.
- If you can’t pay back the loan, the unpaid balance will be treated like a distribution, meaning you’ll have to pay taxes and possibly penalty fees.
There are some benefits to being able to borrow from and pay interest back to yourself, but they do not outweigh the drawbacks.
Updated January 11, 2011 and originally published March 23, 2005. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @flexo on Twitter and visit our Facebook page for more updates.