If you’re deep in debt and not sure how to get out, borrowing from your 401(k) might seem tempting. It’s a pot of money that’s not tied to any application process, scrutinizing lenders or credit score requirements. Easy fix, right?
Unfortunately, the reality isn’t so simple. When you look at the big picture, borrowing from a 401(k) to pay off debt usually isn’t the best idea. Here’s why.
1. You Must Pay Back Your Loan (If Your Plan Offers Loans in the First Place)
Not all 401(k) accounts allow borrowing. For those that do, if you have a vested balance of more than $10,000, you can borrow up to 50 percent or $50,000, whichever is less. Some plans make an exception for balances below $10,000, allowing a loan of up to $10,000. Either way, you’ll be able to access money quickly depending on your balance. But paying back those funds will take a long time. Payments usually occur over five years and come out of your paycheck. If you leave your job before this period, you may have to pay your remaining balance within 60 days.
2. You Lose Tax Deferment
The beauty of contributing to a traditional 401(k) lies in avoiding paying taxes on that money until you withdraw. To pay back a loan on your 401(k), you’ll have to use taxed income — and it will then be taxed upon withdrawal when you’ve reached the proper age. Ouch!
3. Your Money Loses Its Protection
In general, money you’ve saved for retirement is protected from creditors should you run into financial trouble. If you’re in serious trouble and hoping your 401(k) loan will bail you out, consider other strategies first. You don’t want to give creditors access to money that is currently protected.
4. You’re Borrowing from Your Future Self
While you have an outstanding 401(k) loan, you most likely won’t be able to continue regular contributions. This will severely limit the growth of your retirement fund. Getting caught in a cycle of paying back what you’ve taken out will probably also mean a reduced or delayed retirement payout down the road. This may turn out to be a huge retirement planning mistake.
5. You Probably Have Better Options
While a 401(k) loan can be beneficial for someone in good financial standing who needs assets quickly, it’s a slippery slope for someone in debt. If bill collectors keeping calling, first see what else you can do to ease the pressure. Work to set up a payment schedule and create a budget. With some careful financial management, you can make a dent in what you owe. Borrowing from your 401(k) should be your last resort.
Should You Borrow from Your 401(k)?
Talk to your Farm Bureau agent about your financial goals and how we can help you achieve them.