When is Borrowing from Your 401k a Good Idea?

Tax Act

While many financial experts claim you should avoid borrowing from your 401k as much as possible, it may be your only financial life line in certain situations.  Because so many people often don’t have enough or anything at all saved toward retirement, financial experts claim you could be setting yourself up for financial disaster when you are ready to retire.  On the other hand, depending on your situation, it may make sense to borrow.

If you have considered other financial options such as borrowing from friends, family or home equity line of credit, a loan against your 401k may be your last option.  An emergency that may be okay to borrow includes the need of living essentials such as food, grocery items and keeping utilities from being disconnected.  If you have other obligations or are being harassed by debt collectors for items such as medical bills or credit card bills, negotiate a payment plan that will give you time to make payments before considering using 401k funds to pay them off.

It you have a secure job it may be safe to borrow because it helps in repaying the loan amount.  You may have to consider payment amounts that would be applied to what you borrowed if they are automatically deducted from your paycheck.  Also keep in mind; you may be required to pay it back during a set time period. If you leave your job before the loan is repaid, you’ll have 60 days to pay what is due.  At this point, the money taken out may be subject to a 10 percent tax penalty.

You plan to use what you borrow for a smart investment.  This includes using the money to purchase a home, start a business or further your education.  For homebuyers, the repayment period is extended.  Make sure business decisions are thoroughly researched and educational credentials will have additional value for the workplace.

If you are unable to obtain a loan at an affordable rate, borrowing from your 401k may be a low-cost loan option.  People who have filed bankruptcy in the past, for example, may not qualify for a loan at a lower rate. Remember, you may still have to pay penalties for touching your 401k before your retirement age.  You may save interest in choosing to borrow against your 401k but it may not make up for taking the funds out in the beginning.

Andrew writes frequently about personal finance as well as issues effecting both consumers and small businesses, covering everything from credit cards to mortgages to tax reduction.

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