Why You Shouldn’t Borrow From Your 401(k)

It’s tempting. The money is sitting there in an account that is doing nothing for you right now. You may be years or even decades away from needing it. Why not put it to work for you now to buy a home, make a renovation, or pay down some debt? You are paying yourself back with interest anyway! Outside of an emergency event, a loan from your current 401(k) is probably not worth it. Here are 5 things to consider before taking out a loan:

Your retirement could suffer a setback. – The time you are repaying the loan could be spent building your retirement savings. You could also be missing out on potential gains that the loan amount won’t realize. This could be a huge opportunity cost when these gains compound over long periods.

Missing out on an employer match. – At least part of your monthly retirement contributions will now go towards repaying the loan. By replacing your elective deferrals with loan repayments, you could also be missing out on a company’s matching contribution.

A pre-tax contribution is now repaid with after tax dollars. – You may have initially made the contributions with pre-tax dollars but the money that you use to repay the loan will be after-tax dollars. When you retire, all distributions will be subject to tax even though money has been added back to the plan with after-tax dollars. You are essentially paying taxes twice on the loan amount.

What if you can’t pay it back? – If you don’t pay back the loan within the given repayment period, usually 5 years, the balance of the loan is an early distribution and becomes taxable. You could also be subject to a penalty, if you are under age 59 ½.

If you change jobs, the loan becomes due…even if you’re fired– If you leave your job, you’ll have to pay back the entire balance. Otherwise, it will be treated as an early distribution and you’ll pay taxes and potentially a penalty on the balance. This is even the case if you are fired from your job. You would have to pay back a loan at what may be the most inopportune time.

We are in an age of uncertainty surrounding Social Security and pension plans are being diminished in the workforce. Retirement savings will need to provide the difference to cover expenses. If you still decide that a loan is right for you, check with the administrator of your plan about associated fees. If you are still unsure, reach out and I can help you make this important decision.

 

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual, nor intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

 Securities offered through LPL Financial, Member of FINRA/SIPC and investment advice offered through Stratos Wealth Partners Ltd., a Registered Investment Advisor. Stratos Wealth Partners, Ltd. and Lob Planning Group are separate entities from LPL Financial.