Beware perils of borrowing from 401(k)Published 5:01pm Friday, July 29, 2011
By WAYNE CURTIS / Community Columnistdressing
As the economy struggles to recover, you — like many other borrowers — may have found it difficult to get a loan. And this has probably caused you to look for alternative sources of funds.
Growing numbers of people — including lower-income individuals as well as those with high incomes—are resorting to borrowing from their 401(k) retirement plans. For most of them, this is a serious mistake.
Financial experts advise against borrowing from these accounts. There are several reasons they caution against such action.
An important consideration is that when you invest in your 401(k), the money you put into the account is sheltered from income tax.
But when you pay back the debt, you use after-tax dollars that your employer typically withholds from your paycheck.
More importantly, if you leave your job, you have to pay off the loan within a specified time. If you fail to repay it, this will be treated as a withdrawal, and you will be taxed on the remaining balance. You will also incur a 10 percent early withdrawal penalty if you are less than 59-and-a-half years of age.
In addition, since there are generally no restrictions on what you can use a 401(k) loan for, this can be tempting if you are not disciplined. There is nothing to stop you from spending the money on non-essential items, such as an extended vacation or expensive jewelry.
This does not mean you should never borrow from your 401(k).
There are times when this is justified. You may have critical needs with no other source of income. But for most of us, these are rare occasions.
If you must use this approach, borrow only the amount you need. And strive to repay it as soon as possible.
Debt is always risky. But as noted above, a loan on your 401(k) has additional risks.
If you have questions, you should contact a tax professional.
Wayne Curtis, Ph.D., is on the board of directors of First United Security Bank. He may be contacted at firstname.lastname@example.org.