401K Loan Advice - Borrowing Against Your 401K

The best 401k loan advice there is, is to avoid it. Borrowing against your 401k is a dangerous idea, in large part because of what a great deal it sounds like at first.

With this financing option you get a very low interest rate, and the rate you do pay goes right into your account. I can't imagine a better deal than that when you're looking for financing--however, there are some risks involved that a lot of people choose to ignore, believing they won't affect them.

You have to repay the balance within five years. If you don't, the balance will be treated as though you cashed out in the first place. Also, if you leave your job within the five years you are making payments, the balance suddenly becomes due and whatever you haven't repaid will be treated as though you cashed out.

What's so bad about cashing out? Well, you have to pay state and federal taxes, as well as a ten percent early withdrawal penalty. This can easily add up to thirty to forty percent of the balance, depending on your tax bracket. This will have an effect on money you're losing now, and for the future when you're retired. This is a very heavy price to pay.

While you may firmly believe that you will not be leaving your job in the next five years, five years is a long time. You could have a better opportunity come up elsewhere, your spouse could need to move, a family member could become ill, or you could end up fired. A lot of things happen in five years.

Even if things do go smoothly and you repay the balance in those five years, you still lost a lot of time where that money you took out for your 401k loan could have been invested and earning you returns, hurting your retirement savings.

While borrowing against your 401k is certainly a preferable option to cashing out, it's still best to consider other options before looking at one of these loans.