3 reasons not to borrow from your 401(k) (2024)

FAQs

3 reasons not to borrow from your 401(k)? ›

You're missing out on investment growth

If you've borrowed for the maximum term allowed — five years (longer if you use it to purchase a home) — all that inactivity can make a hefty dent in your retirement savings from which it can be difficult to recover.

You're missing out on investment growth

If you've borrowed for the maximum term allowed — five years (longer if you use it to purchase a home) — all that inactivity can make a hefty dent in your retirement savings from which it can be difficult to recover.

Common arguments against taking a loan include a negative impact on investment performance, tax inefficiency, and that leaving a job with an unpaid loan will have undesirable consequences. If you don't want to tap into your retirement savings for money, you can always look into borrowing a personal loan.

Some of the reasons why you can't borrow from your 401(k) include lack of spousal consent, you are nearing retirement, you have exhausted your 401(k) loan limit, you are no longer working for the employer, or if your job position is at risk due to ongoing restructuring.

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For example, some 401(k) plans may allow a hardship distribution to pay for your, your spouse's, your dependents' or your primary plan beneficiary's: medical expenses, funeral expenses, or. tuition and related educational expenses.

You could face a high tax bill on early withdrawals

If you're under 59½, you may get hit with both ordinary income taxes and an additional 10% federal income tax. What's more, you could miss out on years of potential investment gains.

After other borrowing options are ruled out, a 401(k) loan might be an acceptable choice for paying off high-interest debt or covering a necessary expense. But you'll need a disciplined financial plan to repay it on time and avoid penalties.

Deferring Social Security payments, rolling over old 401(k)s, setting up IRAs to avoid the mandatory 20% federal income tax, and keeping your capital gains taxes low are among the best strategies for reducing taxes on your 401(k) withdrawal.

If you do not pay off the loan in full within the 90 day window, the total outstanding balance will be considered a loan offset. With a loan offset, the remaining loan amount is reported on a 1099-R and will be treated as a taxable event.

Money withdrawn from your 401(k) account will not be earning interest, so your retirement savings might not grow at the same rate. Using a personal loan to consolidate debt may save you money in interest on higher-rate debts which could help you manage your budget effectively or add to your savings.

Do you really pay yourself back from a 401k loan? ›

The ability to take out a loan helps make a 401(k) plan one of the best retirement plans, but a loan has some key disadvantages. While you'll pay yourself back, you're still removing money from your retirement account that is growing tax-free.

Generally speaking, you can't withdraw from a workplace retirement plan until one of the following happens: You leave your job due to death or become disabled. The plan is terminated and isn't replaced by a new one. You reach age 59 ½

You can withdraw your contributions (that's the original money you put into the account) tax- and penalty-free. But you'll owe ordinary income tax and a 10% penalty if you withdraw earnings (i.e. gains and dividends your investments made inside the account) from your Roth 401(k) prior to age 59 1/2.

Depending on your situation, you might submit documents such as an unemployment notice, medical bills, military orders or a divorce decree. It's also helpful to provide verification of all sources of income (paystubs, W-2s and 1099s) as well as account statements to show your current financial status.

You will not need to submit any documentation with your application to prove that you meet all of the qualifications to take a hardship withdrawal.

If you withdraw from your 401(k) before you reach age 59½, you may have to pay a 10% additional tax on the distribution. This tax applies to the amount received that you must include in income. The 10% tax will not apply to distributions before age 59½ if you qualify for an exemption.

Unlike other loans, 401(k) loans generally don't require a credit check and do not affect a borrower's credit scores. You'll typically be required to repay what you've borrowed, plus interest, within five years. Most 401(k) plans allow you to borrow up to 50% of your vested account balance, but no more than $50,000.