According to the Wall Street Journal, the number of Americans taking loans against their 401(k) plans is increasing because most plans allow participants to borrow funds to purchase a home or to avoid foreclosure.
But just because the avenue is there, though, doesn't mean that borrowing from a 401(k) is a good idea.
Here's why: When you put money into a 401(k) plan, you use pre-tax dollars but when you repay a 401(k) loan, you use post-tax dollars.
Therefore, if your tax rate is 28%, it takes $1,388 of income to repay each $1,000 increment of your loan. Then, when you withdraw the funds at retirement, the money is taxed again.
Double-taxation is costly, but the other less-well-known impact of a 401(k) loan is that you can lose the long-term power of compounded interest on your entire portfolio.
This isn't to say that a 401(k) loan is bad, it just may not be right for you. So, if you're planning to withdraw from your 401(k), be sure to talk with a qualified financial professional first.
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Great post. I also advise against using that money. But, in some cases that may be the only option.
J.
Wow Ilyce! That does not sound like a good deal. I am sure many out there are doing this practice and are not aware of the ramifications from borrowing money from their 401, thanks! Great Post!
Don't sometines when you borrow from your 401k you actually have to pay yourself interest so you fund is making money of you. This cancels some of the tax burden.
I just explained this samething to my client this week. Great Post
Illyce, Thanks for a good review of this important subject. Do you also plan a more indepth review ?
Is this true even with self directed 401K's?
Your right on. People should not take anything from their 401(k). This is a bad thing. There are many more ways people need to save and can use that to help them.
Illyce,
I didn't know this. Thanks for the information. Your posts always have great info.
Excellent Info Ilyce! This shoudl be the absolute last resort...