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An ex­cerpt from our Em­ployee Bene t Views blog, writ­ten by Robert C. Law­ton, founder and pres­i­dent of Law­ton Re­tire­ment Plan Con­sul­tants.

Why 401(k) loans are the worst pos­si­ble in­vest­ment

Tak­ing a 401(k) loan is such a bad in­vest­ment choice that it should not be al­lowed in any 401(k) plan other than for hard­ship rea­sons. And yes, it is an in­vest­ment be­cause when plan par­tic­i­pants take 401(k) loans, they be­come one of the in­vest­ments in their ac­counts.

Be­fore al­low­ing work­ers to pull money out of their ac­counts, em­ploy­ers and em­ploy­ees should con­sider th­ese im­por­tance fac­tors.

Bor­row­ers of­ten lose the com­pany match. Many par­tic­i­pants who bor­row from their 401(k) ac­counts end up stop­ping or low­er­ing their 401(k) con­tri­bu­tions while they are pay­ing back their loans. is of­ten re­sults in the loss of 401(k) match­ing con­tri­bu­tions when a par­tic­i­pant’s con­tri­bu­tion rate falls be­low the max­i­mum matched per­cent­age.

Job changes can force de­faults. Most par­tic­i­pants con­sid­er­ing a job change don’t re­al­ize that their out­stand­ing 401(k) loan balance be­comes due when they leave their cur­rent em­ployer. In the case of in­vol­un­tary job loss, an out­stand­ing 401(k) loan can add signi cant pain to an al­ready dif cult sit­u­a­tion. Re­gard­less of whether a job change is vol­un­tary or in­vol­un­tary, most par­tic­i­pants don’t have the nan­cial re­sources avail­able to pay back their 401(k) loans when they sep­a­rate from ser­vice. As a re­sult, a large per­cent­age of th­ese par­tic­i­pants are forced to de­fault. e de­faulted balance be­comes sub­ject to state and fed­eral taxes and pos­si­bly state and fed­eral early with­drawal penalty taxes. Plan bal­ances that leave a 401(k) plan for­ever be­fore re­tire­ment are re­ferred to as leak­age. “Leak­age” from de­faulted 401(k) loans makes it less likely that par­tic­i­pants will build ad­e­quate re­tire­ment sav­ings.

Op­por­tu­nity costs can be sub­stan­tial. As­sume that a par­tic­i­pant takes a $10,000 loan for ve years at 6%. e in­vest­ment ex­pe­ri­ence on that por­tion of the par­tic­i­pant’s balance will be a 6% re­turn for ve years. Had the loan balance been in­vested in the in­vest­ment op­tions in the plan for the same pe­riod, the par­tic­i­pant may have earned a lot more. For ex­am­ple, the ve-year re­turn on the Van­guard 500 In­dex Fund through March 31, 2017, was more than 13%.

In­ter­est on a 401(k) loan is not tax-de­ductible. Any­one need­ing a loan should in­ves­ti­gate the pos­si­bil­ity of tak­ing a home eq­uity loan rst, since in­ter­est on th­ese loans is tax-de­ductible.

To read this blog in its en­tirety, check out

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