401k loans

Are 401k Loans a Good Idea?

by mike on February 17, 2010

There’s that nagging credit card debt that you can never seem to get caught up on.  Not to mention, the doctor bills from the baby you had last year.  Throw in the financing from the furniture store you bought your bedroom set from two years ago and it seems impossible to ever make a dent in any of it.  If only you had a big chunk of money to pay all of this off and start over, then life would be good.  Then, all of a sudden, it hits you.  “I have been putting money into my 401k for years,” you think.  Why not take a loan against that money, after all then you will be paying yourself back.  Let’s take a look at why that is not a good idea.

1.     You are unplugging a good investment.

Most of the time it is seen as a positive because you are “paying yourself” back three to eight percent interest rather than paying the bank that money.  The problem is you are unplugging a good growth stock mutual fund (because that is what it should be in if you are following a good investment plan) that should be averaging over time twelve percent or so.  In other words, you are killing the interest you are getting on leaving it alone when you pull out a chunk of it and pay yourself back. The math just doesn’t work.  The next issue is an even bigger problem.

2.     The loan is due in full when you leave the company.

“I’m not going to leave my company” you might be thinking.  I beg to differ, you will 100% for sure leave the company.  Whether you quit, get fired, change jobs, or die, you will leave the company.  When you leave the company, you must pay back the loan within sixty days.  If you can’t (which I would be willing to guess you cannot considering why you took out the loan to start with) pay it back within that sixty days, it is considered an early withdrawal.  That means you will have to pay early withdrawal penalties plus your tax rate on the money.  That is the last thing you need in a situation like this.

I hope I have sufficiently convinced you to not take out a loan against your 401k.  I never recommend it as a way to solve your current problems.  Instead, you need to set up a plan, work the plan, and pay of your debt systematically.   If you already have a 401k loan, you need to include it in your debt snowball and pay it off as quickly as possible.  Now, you may be thinking that you have another way to get your debt paid off: a debt consolidation loan.  We’ll take a look next time at why that is also a bad idea.