Think Twice Before Borrowing from a 401(K)

William Suplee |

Outside of an emergency where you have no other resources, taking a loan from the 401(k) plan is a really bad idea. The most common reason people do this is simply because it’s easy. You are just borrowing money from yourself and paying yourself back. However, several unfortunate and unexpected things can happen when you borrow from your 401(k) plan. The most obvious one is that you hurt your ability to save for a secure retirement through tax-free growth. Keeping money invested over the long term is more important than picking the right asset classes to invest in. The power of compounding is amazing but you need to leave the money in your investment account.

Probably the worst situation that could occur would be to borrow money from your 401(k) plan and then subsequently lose your job. If this happens, you most likely will not be paying back any of the loan and your 401(k) plan will send a notice to the IRS that you defaulted on your loan. This will be deemed an early distribution. You will have to pay taxes on this distribution and an additional penalty unless you qualify for one of the few exceptions due to age. Having additional tax bills come due just as you lose a job takes a single problem and turns it into two problems.