Borrowing From Your 401(K) Can Be a Bad Idea. Heres Why.

Borrowing From Your 401(K) Can Be a Bad Idea. Heres Why.Credit ShutterstockProfessional Ask most financial advisors about borrowing from your 401(k), and their response will be brief and blunt Dont do it.Those three words sum up the prevailing sentiment on the subject. Still, the dire warnings dont scare everyone from tapping into their nest egg.According to Forbes, roughly 40 percent of individuals with a 401(k) borrow against their plans at some point. If youre considering taking out a loan against your plan, know the basics first.Editors musikelende Looking for an employee retirement plan for your business? Fill out the below questionnaire to have our vendor partners contact you about your needs.Are you eligible for a loan?That answer depends on your employers plan. Employers are not required to allow loans against retirement savings. Some plans dont while some allow multiple loans. Most, though, have a minimum amount you are allowed to draw from your 401(k). Check with your plan administrator or read your summary plan description to know if a minimum applies, and, if so, what that amount is.How much money are we talking about?Minimum loan amounts vary, but the maximum is $50,000, or 50 percent of your vested balance, whichever is less. Vesting rules vary also, so check with your plans administrator.What is the cost?Opportunity costs aside (well get there in a minute), the interest rates on 401(k) loans can be very attractive compared to other borrowing options just 1 percent over the prime rate in many cases.Interested in setting up retirement options for your employees? Check out the best employee retirement plans of 2019.How long before I have to repay?Typically one to five years, unless the loan is for the purchase of a primary residence. A repayment schedule will be part of the loan agreement. For details, check your plan.Why do experts advise against a 401(k) loan?Because they believe in the value of saving for retirement, and they dont want you to fall off track. Here are the biggest reasons for keeping your hands off that nest eggYour earning potential takes a big hit.Missed growth opportunities is the primary and most obvious reason to avoid borrowing from your 401(k). Recent market volatility aside, over time, your managed investments will grow. The mora dollars you have working for you, the more you can make. Pulling money out reduces your earning potential. The closer you are to retirement, the harder it is to catch up.For the duration of your loan, you cant contribute to your 401(k). According to Charisse Mackenzie, a financial advisor and president of Saturn Wealth, most people who borrow from their 401(k) stop contributing to their plan while the loan is outstanding. In fact, many plans rule out contributions for the duration of the loan. Since your employer cant match what you dont contribute, that free money youd be getting in matching funds dries up too. Thats a double whammy that you may come to regret in the future.When you do have to repay the loan, your take-home pay is reduced. Eventually, you have to repay yourself. Most loan terms range from one to five years, and payments come from payroll deductions using after-tax dollars. This decreases your take-home pay to less than what it was before you needed the cash.Youre locked into your job during the duration of the loan. Changing or losing your job means youll have to repay the debt. While its true the Tax Cuts and Jobs Act of 2017 gave job-changers more time to come up with the funds, it didnt remove the requirement to repay the loan. Regardless of your plans wording, you have until the deadline for filing your income taxes to get that money into an IRA. If you miss the deadline, the outstanding loan amount will be considered a distribution, and youre liable not only for the taxes, but youll pay a 10 percent early withdrawal penalty (assuming youre under 59 1/2). This is called default, and according to Forbes , it happens to 10 percent of people who take out 401(k) loans.Is it worth it?Real emergencies happen, and, sometimes, dipping into your retirement savings is the least of all possible evils. Charisse Mackenzie points out three reasons a 401(k) loan might be your best option.The low interest rate could be better than anything else available. Theres typically a quick turnaround time to obtaining a loan, and, in an emergency, that can be key. Finally, and this could be the big one, theres no credit check. Since borrowing from oneself is not a loan in the traditional sense, it is not reported to credit bureaus.In the end, the decision is yours. Weigh your needs, check your other options, and make sure you understand the terms of your plan. If you take out a loan, have a plan to repay your future self as quickly as possible and get back in the savings game. Joyce Walsack Joyce Walsack has spent her career working at small businesses and knows the many challenges business owners face. She lives in the Adirondacks Mountain in upstate New York where, when shes not shoveling snow, she writes young adult fiction, enjoys boating on Lake George and hiking in the woods. 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