Taking a loan off of your 401(k) account is one of the most misunderstood financial moves. Everyone from your colleague in the cube next to you, to the folks in H.R. will tell you it can be a great way to get your hands on some cash because the interest rate you pay is pretty low and you are paying back the interest to yourself.
Don't fall for that crap. Here's why taking a 401(k) loan is a really bad move:
- You originally invested in the 401(k) with pre-tax money. But if you take out a loan and then repay yourself, you will put money back into your account that is after-tax money. That is, money Uncle Sam has already taken his chunk out of. Now let's jump ahead a few decades and you are starting to make withdrawals from your account. Every penny you withdraw from a 401(k) is taxed at your ordinary income tax rate. So that money you put back into the account when you repaid your loan is going to get taxed...AGAIN. You are going to pay tax twice on that money. Please explain the logic in that.
- Your 401(k) loan is only good for as long as you stay at the company. If you are laid off, or decide to take a new job you typically will need to repay the loan within a few months. If you don't, the amount of the unpaid loan will be treated as a withdrawal, and since you will be under 59 1/2 that means you would be stuck paying a 10 percent penalty as well as paying tax.
- Your 401(k) money is a long-term investment. You sock it away and let it grow over time. To profit, you need to have the money invested when the markets move up. If you pull out your money for a loan, you have lost the opportunity to make money when the markets are on a bull run.