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Should your borrow from your 401k?

The only time you should consider borrowing from your 401k is to pay off extreme debt or during a true emergency. With a 401k account being geared toward retirement, there are several factors to consider when looking to borrow money from your 401k.

Advantages of borrowing from your 401k

  • No credit check - Borrowing from a 401k account doesn’t require a credit check. If you have trouble getting credit and really need the funds, borrowing from your 401k could be a viable option — so long as your 401k permits loans.
  • More convenient - To borrow from your 401k actually requires less paperwork than other loans, making it quicker than the alternative.
  • Competitive interest rates - The interest rate on a 401k loan depends on the individual plan’s terms, though this rate tends to be lower than personal or credit loans. In addition to this, you’ll be paying yourself interest instead of a finance company.

Disadvantages of borrowing from your 401k

  • Opportunity cost - Your money will inevitably work harder the longer you let it stay in the account. Because of this, you will not benefit from the higher returns that comes from leaving your money be. In addition to this, those who take loans from their 401k tend to stop contributing altogether. This means even less returns over the course of your life.
  • Risk of job loss - If you take out a 401k loan and don’t pay it, it will be considered a distribution. This will then be subject to income taxes and a 10% penalty tax if you’re under the age of 59½. If you have an outstanding 401k loan and change or lose your job, your loan will be immediately due. Failing to pay the remaining balance will have tax consequences.
  • Red flag alert - Being in a position to borrow money from retirement savings to fund current expenditures is a red flag. You may be able to pay off your emergency bills and balances, though you most likely won’t have the ability to cover another emergency and will end up doing yourself more harm.

Most financial experts will caution against borrowing from your 401k. Of course, this opinion will differ depending on the circumstances. Always consult with a professional before making such a big decision.