The problem with 401(k) loans
As people struggle during the tough economy, many are looking for easy ways to get their hands on cash. For some, the lure of borrowing their own money is just to great and what seems likes an easy decision could very well backfire and turn out to be not just a bad idea, but a really bad idea. Let’s look at some of the ‘faux’ pros and cons of a 401(k) loan.
The first argument that people use is that they will pay themselves back with interest and therefore they are guaranteed to be improving their situation. The problem with this theory is pretty evident when you peel back the first layer of this messy onion. Unless you are going to borrow money from someone to pay back the principle and the interest, you will have to take money out of your own pocket to pay back the loan. If the money is coming out of your pocket, you will have already paid taxes on that money. Later, during retirement when you withdraw the money, you will pay taxes again. I don’t like taxes the first time I pay them, I definitely don’t want to pay them twice.
Another argument for taking money out of your 401(k) is you want to protect your investment by taking the money out and investing it in some ultra-safe investment during this roller coaster ride the stock market is going through. The problem, getting a guaranteed investment outside of your 401(k) is just as difficult as finding one inside your 401(k) options. Even if you could find a very safe investment, if you want to be able to pay back the principle and interest using investment dollars only, you will have to pick an investment that earns 8-10%. Right now that is pretty hard to do; you are going end up losing money
A third reason not to take out a 401(k) loan, is because of the risk. When you take out the loan, you have to pay it back, and if you leave the company before paying back the whole thing, you will have 60 days to finish paying off the loan (with interest), otherwise the loan is considered income and you will have to pay taxes on that amount. Additionally, if you are under 55, the remaining balance will be considered an early withdraw and you will not only be paying taxes, but you will also be paying a penalty of 10%.
There are other reasons for not taking a 401(k) loan, and here is an article from CNNMoney.com that lists some other troubles with 401(k) loans.
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