When you borrow from your 401k account, you’re decreasing the amount of wealth that you have saved and grown for your retirement. This is a setback that could adversely affect your strategy for growing enough wealth for you to support yourself in the future. Additionally, here are some specific reasons that borrowing against your 401k is always a bad idea.
You’ll Get Taxed
The money you invested into your 401k was contributed tax-free, and those funds are protected for as long as they remain in the account. However, that means any money you borrow will have to be replaced with taxed money, leading you to spend more on repaying the loan. For example, if you pay 32% on your income taxes, .32 cents of every dollar you repay will go to taxes. That amount can quickly add up if you borrow thousands of dollars from your 401k account.
Your Contributions Will Suffer
Most people live on a tight budget that details every expenditure. If you’re contributing 10% of your income to your 401k and you borrow against it, the expense of making loan payments will be added to your budget. What typically happens is that the individual pauses their 401k contributions to allow them to use that money to repay what they borrowed. While that seems like a sensible tradeoff, it means you’re stopping your retirement planning until you fully repay your loan.
You May Not Be Able to Repay the Loan
In most situations, borrowers can repay their 401k loans with little difficulty. However, 10% of borrowers experience job losses or other financial setbacks that prevent them from fully repaying the loan. This makes a bad situation that much worse because a defaulted 401k loan will be converted to an early withdrawal. As a result, you’ll owe income taxes on the amount you borrowed. Additionally, you’ll probably have to pay a 10% penalty for an early withdrawal.
Overall, borrowing money is a bad idea in that it will increase your debt. If you cannot repay that debt before you retire, the wealth you do grow won’t be enough to support yourself throughout your retirement years. The best option is to have an additional savings account that can be used for financial emergencies, vacations, and other expenses. This will help you keep your debts low, and it will protect your retirement savings.