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Should You Take a 401k Loan?

Here are the Pros and Cons of Taking a 401k Loan

401k loans are different than other loans because, in essence, you are borrowing from yourself. You take a loan from your 401k balance and then pay interest back into your account. We wouldn't recommend you take a 401k loan unless your other loan options are really limited, however, there are cases where it makes sense. Here are the pros and cons to help you decide:

Pros of taking a 401k loan

  • You are borrowing money that you already have, so you are really not going more in debt (but you are still reducing your retirement account during the loan period).
  • It is better than taking credit card loans or payday loans.
  • You are paying yourself interest on the loan and not someone else.
  • It is better than cashing out your 401k and paying all of the taxes and penalties.

Cons of taking a 401k loan

  • While the money is out of your 401k account, you are not invested in any assets. That means you are missing out on the potential returns associated with your 401k investments.
  • Employers come and go. If you leave your employer or are forced to leave, the 401k loan will be due immediately, and if you can't pay it back, you will be forced to reclassify the loan as a withdrawal, resulting in tax penalties and early withdrawal fees.
  • There can be fees charged by the plan adminstrator.
  • The terms and provisions of your loan are dictated by your employer or your 401k plan provider and can change at their will.
  • Not all employers or plans let you take loans. If they do, you are usually limited to only a portion of your account, which may not be as much money as you need.
  • Taking a 401k loan is essentially the same as spending money you don't have. You'll have to come up with the money to pay it back from another source, so unless it is a one-time expense or you are going to change your future spending habits, there is a good chance you don't pay the loan back and have to pay tax and withdrawal penalties on the loan.

See Also:  Other 401k articles