You have some money saved in your 401(k) and your company allows employees to borrow money from it. Should you?
Maybe, but probably not. Don’t be swayed by people who tell you it’s a great idea since you’re simply borrowing your own money and paying yourself interest.
Is borrowing this money earmarked for a good cause?
There’s a big difference between using it for a down payment on a house and taking an expensive vacation. And if you’re thinking you can use it for loan consolidation, how sure are you based on past behaviors that you won’t run up another pile of debts having consolidated and paid off the first pile?
Have you compared all your options for raising money?
Is a personal loan an option? Is waiting until you have saved the amount an option? Is borrowing from family members an option?
Have you weighed the advantages and disadvantages of 401(k) loans?
Advantages include quick approval, the likelihood of a lower interest rate than your other options, a payback period of five years or fewer, and total flexibility as to what you use the funds for.
Disadvantages can be ugly. Leaving your job for any reason requires paying the loan back by the date your next tax return is due; failure to do so means the IRS will treat the loan as a withdrawal, tax you on that amount, and slap a penalty on top of that if you are less than 59 ½ years of age. Ouch.
Perhaps the greatest disadvantage is the loss of the compounding effect for building your savings because the money you withdraw is no longer working for you over extended periods of time.
So, good idea or not?
If you take the loan you are betting that your job situation will not change, that you will have no trouble paying the loan back, and that the loss over time due to missing out on the compounding effect will not be an issue in your future.
Think carefully, and choose wisely.