What to Know Before Borrowing from Your 401K?

Answer 1

Your 401K is a little bit of a reassuring safety net that you'll be fine once retirement time comes, but sometimes, life can throw unexpected curve balls that may leave you feeling the need to start digging a little into your savings. Even though taking a little bit of your 401K out for present use may seem attractive at the time, there are a few things to consider before doing so.

To begin with, taking out a 401K loan is practical if the situation calls for it. However, it's helpful to know that you can't contribute anymore to your 401K savings until you've completely paid off the amount that you borrowed. In most cases, you must begin repaying the loan as soon as your next pay period. For some, this can be the deciding factor in whether or not the 401K loan is even taken out. If you are slow about paying the loan off, you could be in hot water down the line when it's time to retire.

Another thing to think about is the fact that a 401K loan is just like a home loan or car loan. Many people make the mistake of comparing the act of borrowing money from their 401K to heading down to the bank and siphoning some money out of their savings accounts. However, a 401K loan must be paid back just as a regular loan should.

One of the more interesting things to think about before borrowing from a 401K is that the interest you'll pay on the loan will actually be paid to yourself instead of a bank or lender. Because it is essentially your money you're borrowing, the interest cannot go anywhere else except back to you. In a way, this helps you make a bit of a profit off of your loan even though you're still borrowing. If you can pay the loan off in a decent amount of time and quickly begin contributing again, it may not be a bad idea to borrow from your 401K plan.

In general, borrowing from a 401K plan can neither be considered right or wrong. It strongly depends on your situation and how/when you plan to handle the repayments of the loan. The best case scenario, however, is to rule out any other possible solutions to solve your financial troubles before turning to borrowing from your 401K. This is just to keep things safe so that you don't wind up compromising your future retirement savings.