Know your options and the repercussions before you dive in. / Jamie Grill/Getty Images
If you have a 401(k) — particularly a substantial one — it can be tempting to borrow from it. In most cases, however, it’s a dicey move. Here’s why:
You may compromise your retirement.
One of the biggest advantages of a 401(k) is that all deposits occur before they’re counted as income. Moreover, all invested funds grow tax-free. Loans can cut into that crucial growth. “Since so many Americans are woefully prepared for retirement in the first place, the tradeoffs can be significant,” says financial planner Stuart Armstrong of Centinel Financial Group in Needham Heights, Mass.
Repayment may be tight.
You have five years to repay what you borrowed if you stay in your job. But if you leave your job, the time frame is just 60 days.
If you can't pay, taxes and penalties kick in.
The penalty for early distribution is 10%, and “depending on the federal tax bracket and state taxes due as well as the penalty, the total amount could be a sacrifice of up to 40% to 50% of the gross withdrawal,” Armstrong says.
So look to other sources when possible.
Opt to tap into other forms of savings or a home equity loan. Treat a 401(k) loan as a last resort: “In most cases, it still remains a very risky proposition,” Armstrong says.