People are dipping into their retirement funds for big expenses. Here are the pros and cons of a 401(k) loan

Image source: Getty Images

It’s no secret that a lot of people are struggling to make ends meet these days. With the cost of living rising and wages stagnating, it’s no wonder so many people are looking to their retirement savings for help. After all, what’s the point of having cash on hand if you can’t use it when you need it, right? Bad. Borrowing from your 401(k) should be a last resort, and here’s why.

Benefits of borrowing from your 401(k)

There are a few potential benefits to taking out a loan through your 401(k). For one, the interest rate is usually quite low. In fact, most 401(k) loans have an interest rate that’s significantly lower than the rates you’d find on a credit card or personal loan. This can be a great way to consolidate high interest debt and save money in the long run.

Discover: These personal loans are the best for debt consolidation

More: Prequalify for a personal loan without affecting your credit score

Another advantage of borrowing from your 401k is that you are essentially borrowing from yourself. This means no credit checks are required and you won’t have to go through a lengthy application process. The money is already yours, so all you have to do is fill out some paperwork and you could have the money in your hands within days.

The disadvantages of borrowing from your 401(k)

Despite the benefits, borrowing from your 401(k) should be your last resort. There are several downsides to taking out a loan from your 401(k) that you should be aware of before making a decision.

For one thing, if you can’t repay the money, the loan will be treated as a withdrawal and you’ll be subject to income tax and a 10% early withdrawal penalty if you’re under 59. 1/2. Also, if you quit your job (by choice or not), you may have to repay the entire loan immediately. This could put you in a very difficult financial situation if you are not careful.

Another downside to borrowing from your 401(k) is that you’re essentially stealing your future self. When you take money out of your retirement account, it’s no longer there to grow tax-free and accumulate over time. This means you could end up retiring with less money than if you had left your savings alone.

Finally, you can only borrow up to 50% of your account balance or $50,000, whichever is less. For example, if you have $40,000 in your account, you can only borrow $20,000. If your account has $160,000, the maximum you can borrow is only $50,000. There is an exception to the rule. If 50% of your account balance is less than $10,000, you can borrow up to $10,000. Once you take out a loan, you have five years to pay it back and you must make payments at least quarterly. Your employer may also have additional restrictions that may make it more difficult to borrow money from your 401(k).

So should you borrow from your 401(k)? Ideally not. If you’re sure you can repay the loan quickly and smoothly, it may be worth considering, especially if you need the money for an emergency expense or to consolidate high-interest debt. However, if there’s a chance that paying off the loan will put undue strain on your finances, it’s probably best not to touch your retirement savings. Taking out a loan from your 401(k) can reduce your retirement savings and can have a significant impact on your ability to retire comfortably.

The Ascent’s Best Personal Loans for 2022

Our team of independent experts have pored over the fine print to find the select personal loans that offer competitive rates and low fees. Start by reviewing The Ascent’s best personal loans for 2022.

We are firm believers in the Golden Rule, which is why editorial opinions are our own and have not been previously reviewed, approved or endorsed by the advertisers included. The Ascent does not cover all offers on the market. The editorial content of The Ascent is separate from the editorial content of The Motley Fool and is created by a different team of analysts. The Motley Fool has no position in the stocks mentioned. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Previous Jewish Women's Union Holds Tea for Domestic Workers at Jabulani Leisure Center
Next Evangelical students often feel misunderstood