The Advantages and Disadvantages to 401(k) Loans

Due to a struggling economy, many people are having trouble finding the funds to pay off debt or cover a down payment. And with banks tightening their lending criteria, more people are looking into withdrawing from a 401(k). Consumers find this appealing because the money borrowed from a retirement account is not automatically subject to tax and early withdrawal penalty, nor does it require you to demonstrate a hardship. It may sound like the perfect solution, but 401(k) loans do come with risks. Here are a few important questions to ask before taking out a 401(k) loan:

Does my retirement plan even allow it? Borrowing from your account may not even be an option. Many smaller companies will not include a loan option but most large companies will. Check with your benefits administrator to see if your employer offers 401(k) loans.

Do I feel secure in my job? If you get laid off or decide to leave your job while you still have an unpaid loan, you’ll need to pay it back quickly. If you don’t pay it within 60 to 90 days, the outstanding balance could be classified as an early withdrawal and you could be forced to pay income taxes on that money.

Do I have an emergency fund or other ways to secure a loan? A 401(k) loan should be looked at as a last resort. Consider other loan options before borrowing from your retirement account because the interest on a 401(k) loan is typically higher than the prime rate.

Am I willing to absorb the opportunity costs? Taking money out of your retirement account means you’re missing out on the opportunity for that money to grow. If you’re not contributing to your 401(k) then you aren’t taking advantage of your company’s matching fund and thus missing out on significant earnings.

For more information on borrowing from your 401(k), visit U.S. News.