If money problems arise and you don’t have savings to tap into, you might be tempted to withdraw from your 401(k) plan instead of using alternative options like credit cards or taking out a loan. Many people are of the mindset that because they’ve paid money into a 401(k), they’re perfectly entitled to take it out again as they see fit. In reality though, it doesn’t work like an extended savings account and shouldn’t be treated as such unless you want to run into problems. Here are some of the reasons why I’m not in favor of borrowing from your 401(k) unless there really is nothing else to fall back on:
1. It affects your pay check. If you borrow money from your 401(k), you’ll find that your take home pay is less for the time that it takes you to replace the money. This is because you pay the money back through payroll deductions. For those who are already on a tight budget, this could create all kinds of problems for meeting your monthly bills and could ultimately tip you into debt if you’re not already in that position.
2. Your retirement savings can be thrown off track. In the long run, you’re hindering how much your retirement savings can grow due to the fact that you’re not earning interest on what you’ve borrowed. On top of this, some 401(k) plans prevent you from making contributions while you’re paying back what has been borrowed so you can also miss out on these and the interest that they would have brought. To put it bluntly, there’s less money in the retirement pot, which is hardly a good thing.
3. You can find yourself in a mess if you leave your job. If you leave or lose your job before you’ve paid everything back, you could be forced to pay the outstanding balance within 60 days of working your last day for the company. This may be impossible depending on how much you’ve borrowed, in which case the loan is looked at in the same manner as an early withdrawal and you’re in line for penalties and income taxes. This is something to strongly consider if you’re not confident about job security.
For me, borrowing from a 401(k) would be an absolute last resort if all other doors had been closed to me. Apart from throwing your retirement pot off track, you also run the risk of having to pay the loan back in a very short time period to avoid penalties and taxes. This won’t always be possible, especially if you’ve been laid off and borrowed a significant amount of money from your 401(k). I personally find this drawback very off-putting, because jobs can be lost out of the blue. If it’s an absolute emergency and you feel like you could pay back the borrowing quickly, then you could consider tapping into your 401(k) and accept the potential downsides, but I’m not a fan of using your retirement funds to pay off debt.
(photo credit: annia316)