Risks of Borrowing from your 401K

borrowing from your 401KMany Americans have worked real hard to make sure that their 401K and IRA will give them the maximum benefits when the time comes. When economic conditions seem to be tougher and there’s a need for quick cash, borrowing from your 401k can be a very tempting choice. In fact, the idea of borrowing from your money and paying yourself interest accrued by the loan looks the best option to take. The truth is that borrowing from your 401k is not that simple and you better think twice before you make a huge mistake that you’ll regret in the future.

Remember that retirees get half of their income from Social Security and it’s the only income you’ll be guaranteed to have for your lifetime. Borrowing from your 401k takes complex calculation, specially when you don’t know the inflation rate for the next years. There were many rumors that the Social Security will soon be broke with its current system, but changes are coming. This doesn’t mean that borrowing from your 401k will be easier. In fact, it is wise for you to keep your hands off your 401k funds, unless there’s no other option left.

Dont Borrow from your 401K. Here are Five Reasons Why Borrowing from Your 401K is a Bad Choice:

  1. There’s always a risk involved when you’re borrowing from your 401k. Instead of growing the earnings of your fund, you are sabotaging its earning potential by reducing the principal value of your 401k account. There are provisions that prevent you to make contributions until the loan is paid. You are then losing money.
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  1. You can borrow up to 50% of your 401k account’s value. The law allows you to repay in 30 years, although majority limits it by ten. If you have a big loan, chances are, you’ll take time to repay it. You lose your opportunity to double your 401k earnings and your funds wouldn’t reach the higher amount it can, that is, if no loan was ever made.

  1. Borrowing from your 401k should be done with careful planning and forecasting of your potential future incomes. This is very tricky, whether you are an entrepreneur or an employee. Businesses rise and fall like the volatile market and you must have plenty of monetary reserves for emergency cases.

  1. You will be stuck in your current job if you plan to borrow from your 401k account. The law requires you to pay your loan in full if you leave your current job. You are trapped and you might miss better careers on the job market that will let you earn and save more.

  1. If you fail to repay, there will always be consequences. You will incur taxes that could add up to 30-40 percent of your outstanding loan. Failure to pay on time can be very costly. If you are making a monthly interest payment of $400 and you belong to the 28% tax bracket, this means you will be paying $512. Also, you will pay a 10% penalty allocated for federal and state income taxes. Since borrowing from your 401k means availing a consumer loan, there are no tax deductibles for you to take advantage of.
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Reassess Your Priorities

Maybe it’s time for you to reassess your lifestyle and do a serious financial makeover. Are you living beyond your monthly earnings? Just because your credit cards are maxed out and you have piles of bills to pay doesn’t mean you can justify it by borrowing from your 401k account. There are other alternatives like home equities, a zero-percent balance transfers, lending clubs, banks, and credit unions. You can even seek the help of your family, colleagues, and friends. You may also come up with resourceful ways of keeping your money at a safe level by scouring your home for things you don’t need and offer it up for sale. Borrowing from your 401k removes the hassle of credit checks and lengthy, frustrating loan processes, but, is it really worth all these risks? THINK!