Why You Should Avoid Taking Out A 401(k) Loan

Picture courtesy of El Paso Herald

When times get tough financially, many people think that borrowing money from their 401(k) plan is a good idea that does not require a lot of effort. After all, the money in the account won’t be needed until the future, giving you plenty of time to replace it, right? Unfortunately, the situation is not as clear cut as it might appear. Taking a loan from your retirement plan can have a number of serious consequences that many people do not think about before they make their decision. Here are some reasons why you should avoid taking out a 401(k) loan.

Stringent Repayment Terms In Certain Conditions

If everything in your life continues to go as you planned, then you would probably have no problems paying back the loan according to the original loans terms. However, if you must leave your job or are fired, then the entire balance of the loan is due within 60 days or you will be hit with hefty tax and penalty fees. According to the Financial Literacy Center, more than 80% of workers who left their jobs with a 401(k) loan unpaid defaulted on that loan. Overall, one out of 10 401(k) loans are not repaid.

Lost Contributions

In many cases, people that take out a 401(k) loan reduce the amount that they contribute to their retirement account during the time that they are repaying the loan. This not only reduces the amount you are able to deposit, but also affects the amount of interest you are able to earn on the account. These lost contributions can end up costing you many thousands of dollars that you would need during your retirement years. You can’t make up the contributions you lost.

Additional Taxes

Many people do not realize that the money that they use to pay back a 401(k) loan will be taxed twice, leading them to pay more in taxes than they normally would. The money that you are returning to the account has had income taxes and other taxes taken out when it was paid to you as income. This money will be taxed again once you begin taking withdrawals from the account during your retirement years. While the interest rate offered for the 401(k) loan may be attractive compared to other loans on the market, it could end up costing you a lot more in the long run if you are not careful.