3 Reasons Not to Borrow Against Your 401K

If you leave your job – whether it’s voluntary or involuntary – the balance of the loan will be due within 60 days.  If you don’t repay it, you’ll face a 10% early withdrawal penalty and you’ll owe federal and state taxes on the amount you borrowed.

Your paycheck will be less until you repay the loan.  Getting the 401K loan payments taken directly out of your checks is good because you’re less likely to become delinquent.  However, you’ll be bringing home a lower paycheck until the loan is paid in full.  This means, you’ll have to change your lifestyle to accommodate the decrease in income.

You set back your retirement savings.  Typically, you can’t contribute to your 401K until you’ve repaid the loan, so during that time, your retirement savings isn’t really growing.  If you have a retirement goal to reach (which you should), you’ll have to save more after the loan’s repaid or delay retirement.  Not only do you miss out on those extra contributions, you also miss out on the interest payments you would have gotten if you hadn’t taken out the loan.

All Financial Matters does a nice analysis of the cost of taking out a 401K loan.  It includes a lot of assumptions, but the net is a 401K loan costs more in taxes and sets you back in terms of savings.

Alternatives to 401K Loans

Instead of borrowing against your 401K loan, seek some other alternatives.

• Another savings account
• A credit card
• A home equity loan (interest paid is tax deductible)
• A bank loan

Your car depreciates the day you drive it off the lot.  If you took out a $30,000 loan to buy a brand new car, then tried to sell or trade it, you would not recover the full $30,000 and would end up owing the bank,

If you can’t afford to buy a new car, don’t try to justify the purchase by convincing yourself it’s an investment.  Even if you pay for the car in full, it’s still not an investment.