Don’t Borrow From Your 401(k)

If you need to get your hands on some money, it can be tempting to borrow from your 401(k) account. Resist that urge, though, because doing so means shortchanging your future financial security.

First, understand how 401(k) loans work. Typically, you’re allowed to borrow up to 50% of the vested funds in your account, or up to $50,000 — whichever is less. You’ll generally be expected to make payments on the loan (plus interest, which goes into your account) at least every three months, and you’ll have to pay the loan back entirely within five years. (If you borrow the money to buy a home, the term of the loan can be longer.)

If you don’t pay back the loan on time, any remaining balance will be considered withdrawn, and it will be taxable income. Plus, if you’re withdrawing before age 59 1/2, you’ll face a 10% early withdrawal penalty. Note that if you leave your job for any reason, the loan will be due for full repayment. All that might sound doable to you, but many borrowers find that it’s harder than they expected to repay the funds on time, perhaps because other financial emergencies come up.

Any money you remove from your account for a few years — or forever — won’t be able to grow for you during that period. So before borrowing from your 401(k), ask yourself whether you really need the money. If it’s for a kitchen remodel or a big-screen TV, just forget it. If you do need it — perhaps for a major car repair or because you’re suddenly out of work, see if you can get the money elsewhere, such as by taking on a part-time job.

Try not to cash out your 401(k) when you change jobs, either. Even if you have saved only a modest sum there, leaving it to grow can make a big difference in the future. A $25,000 account that grows for 20 years, averaging 8% growth annually, will end up worth about $116,500.