Disadvantages of Borrowing from your 401k

There are a number of different places where loans are available but some are better than other. The 401k offers you a way of borrowing against your retirement funds in the form of a loan while not putting yourself into debt with a lender. It is almost like being in debt with yourself, except with someone else managing it.

There are many advantages to borrowing against the 401k. This might be the reason by so many people are choosing this option. There are no credit checks, and the interest that is being paid, goes back into the fund. These are only two of the advantages and the list goes on. However, you must remember that there are also the disadvantages to consider.

Loss of Investment

Possibly one of the biggest disadvantages of borrowing money from your 401k is that you will be losing a part of the investment. The 401k works as a retirement investment and serves to earn you interest dollars. By taking out money, you are removing a part of the money that can collect this interest, therefore earning less.

The amount of interest that you lose will depend on the amount of money being borrowed and the length of time it takes to pay it back. Most loans are to be paid back within five years but for the purposes of purchasing a house, the term may be longer.

Loss of Retirement Funds

It is not just an investment that you are possibly losing out on, but also funds for your retirement. Money is harder to obtain these days and even more difficult when you are retired. Many individuals have to take up a part time job to survive. The 401k is supposed to assist you by giving the funds that you need to stay retired. Borrowing money from the 401k defeats this purpose to a certain level.

On another note, you can’t pay more into this fund until you repay the loan. If you have the loan out for five years, you cannot contribute for that entire time. This reduces the amount of retirement by a great percentage.

Loss of Money on Taxes

When you are paying back the money that you have borrowed from the 401k, you are paying with money that has already been taxed. After you start taking out your 401k funds at the time of retirement, you have to pay taxes on the money as if it were income. This means that you are paying twice the taxes and can amounts to hundreds or thousands of dollars.

Less to Live On

The money for the 401k repayments is generally taken out of the paycheck automatically. Whether or not you have enough money to pay your other bills, this money is coming out. You have to find the money to live on some other way if you don’t have enough in your salary.

Large Non-Payment Penalties

Borrowing money from the 401k doesn’t necessarily make the life easier. If times are tough financially now, they might be even worse when trying to pay back the 401k, especially if the loan isn’t repaid by the end of the agreed term. Not only do you have to pay back the taxes but you also face an extra ten percent fee from the IRS.

Pressure for Repayment in Cases of Unemployment

With the economy still unstable, even the most secure jobs may not be as they seem. In the event that you do decide to borrow money from the 401k and you lose your job, the government does not become kind. They in fact increase the level of pressure to pay back the loan. They give you six months from the time that you lose your job to make the payments otherwise you face a ten percent additional charge.

No Tax Deductions

As of April 15, the rules of the 401k changed in regards to making tax deductions. You are no longer permitted to deduct the interest that you pay on this type of loan. The government is not giving borrowers any breaks this time.

Increasing Temptations

Borrowing money from any lender can become a habit. In the case of obtaining it from the 401k, since it may be slightly easier than receiving funds from the other lenders, it can make this borrowing into more of a habit. The 401k is a serious retirement investment and should be treated as such. Unless you have another method of saving for your retirement, you may want to consider finding funds elsewhere.