There are only a few things in life that will bring me to making the face you see in the picture to the right.
The major thing is telling me that you think that In-N-Out Burger isn't a good burger. Don't even go there.
At a close second, is telling me your going to take a 401k loan because you need to pay for <fill in the blank>.
Why do you do need to borrow from your 401k?
Isn't that what your emergency fund is for?
It should be!
If you're contemplating doing this, here's why you should not take a loan on your 401k…
Unless You Want to Make Less Money During Your Life?
It's really quite simple: if you take out a 401k loan, you will make less money during your life. When you take money out of your 401k account, that money stops growing. Considering that growth happens exponentially, a few hundred dollars today could cost you thousands by the time you retire.
Taking money out now is like saying,
“Yes, I would rather go scoot around in a puddle today instead of relaxing on a fabulous cruise tomorrow.”
Unless You Want to Pay Extra Penalties and Taxes
There's a good chance that you won't have enough money to repay your 401k account in time. After all, if you had enough money to repay it, you wouldn't need to borrow it now.
So what? It's your money right? Not anymore, it's not.
When you get a loan, and then can't make the payment, your unpaid balance is considered distribution, which is a stealthy way of saying that you will pay a ten percent penalty in addition to higher income taxes.
When you borrow against your 401k, you risk of unnecessarily giving away a percentage of your savings.
Unless You Really Like Paying Taxes on Your Money Twice
Technically, the money that you get from your 401k loan isn't taxed, but you will repay it with taxable income. That taxed money then goes into your 401k account until you decide to cash in your savings and retire. At that point, you have to pay taxes again. Essentially, you have just paid taxes twice on your 401k loan amount.
One of the big reasons that people sign up for 401k retirement accounts is so they can avoid paying taxes on the money they contribute to fund. If you take a loan, though, you will end up putting taxed money into your 401k. So, you've basically just ruined one of the best things about having this type of retirement account.
It's like someone asked you “do you want to make tax-free contributions,” and you said “no thanks! I love paying higher taxes for absolutely no reason! Are there any other taxes that I might pay while I'm at it?!”
Are There Exceptions?
There are, but not many. If you're facing foreclosure on your home or some sort of major medical emergency, then taking money from 401k is acceptable. In this case, we're not really borrowing from your 401k; we've just crossed over into taking a hardship withdrawal.
If you need a primer, here's our post on 401k hardship withdrawal rules.
Save Smart by Avoiding Crazy Temptations
If you have a 401k account, then you have made a smart decision that will help you prepare for the future. Don't let short-term financial concerns ruin all of your hard work and risk your retirement planning!