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Britt Erica Tunick is an award winning financial journalist who has spent the past 17 years writing about virtually every aspect of finance. She has mastered the art of boiling down complicated financial topics for readers to understand. |
Borrowing from banks has become a nightmare for most of us. But before you start thinking of dipping into your own 401(k), think twice. Here is why. The Risks of Borrowing from Your 401K By Britt Erica Tunick As banks have heightened their lending requirements following the credit crisis and the fallout that resulted, taking out loans has become more difficult than ever. As a result, many people have been turning to alternate financing sources, such as their own 401(k) plans. While most 401(k) plans allow individual account owners to borrow against their vested portfolio holdings, borrowing from yourself and your future retirement money isn’t necessarily the wisest move you can make. Just like traditional loans, borrowing money from your own retirement plan comes with the requirement it be paid back within a set time period. Failing to do so will trigger penalties. There are also very specific guidelines for what the money in a 401(k) plan can be borrowed for, with first time home purchases being the most common. There’s no doubt the idea of taking a loan from your own savings is more appealing than borrowing from a bank, but before heading down this road be sure to consider some of the following reasons you many not want to do so: -Though the money initially invested in 401(k) funds is pre-tax dollars, the money used to repay loans from these accounts is ultimately taxed twice given that it is post-tax dollars that will ultimately be re-taxed when the funds are eventually withdrawn for retirement purposes. -If there is any chance you will be leaving your job in the near future, you could suddenly be left scrambling to repay your loan far sooner than you ever expected since most 401(k) plans require repayment within 60 to 90 days of an employee leaving their employer. Failure to repay a loan within this period can mean hefty penalty fees. -Though the interest on mortgage payments can be deducted on tax returns, interest on 401(k) loans is not deductible. -Taking a loan from your 401(k) could ultimately prove more costly down the road, as the money removed from the account will not earn interest or benefit from any upward movements in the stock market or your overall portfolio. Money removed during a boom in the stock market could leave you with far greater potential losses than the interest you would have to pay on a traditional mortgage or another form of financing. |
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