Reasons not to Borrow from your 401k

A 401(k) is a great savings vehicle to save for retirement. Most 401(k) plans allow participants to borrow from their account. Although it is allowed, it is not usually recommended unless you absolutely need to. There are many reasons people borrow from their retirement accounts but borrowing for a house down payment is one of the few that are acceptable.

One of the main rules of personal finance is “pay yourself first”. Most plans do not allow you to make contributions to your account if you have an outstanding loan against it. So besides losing the growth of the amount you borrowed you also lose the growth from the contributions you could have made during that time. Also, even if you are allowed to make contributions, if you are making payments towards the loan you may not be in the position to make contributions.

One of the reasons that is usually considered acceptable for borrowing from you 401(k) plan is for a down payment on a home. If you take a loan against your account for a vacation or paying off higher interest debt you may not have the chance to borrow from your account if something happens and you need to borrow money for essential expenses.

Also, by borrowing from your account allows time to work against you. Some calculations suggest that your money can double for every eight years in your retirement account. Most 401(k) accounts allow you five years to repay the loan.  If you take the full five years to repay it you could lose almost fifty percent of the growth you could have had.

If for some reason you are unable to repay the loan in the specified time frame you will owe income taxes on the outstanding balance and a 10 percent penalty if you are under the age of 59½. If you end up quitting your job, most plans require full payment of the outstanding balance in full.

The need to borrow from your 401(k) account may be a sign that you are living beyond your means. Once in awhile extra expenses occur but that is one reason it is important to have an emergency fund. If you find yourself short of funds on a regular basis you need to either find a way to cut your expenses or increase your income.

The main reason for a 401(k) account is for retirement saving and should not be considered as a source of money for other reasons unless absolutely necessary.