Podcast Episode 333: Is It a Bad Idea to Take Out a 401(k) Loan?
Part of managing your finances and making the best decisions for retirement is understanding how to best utilize the assets you have in your possession. One of the largest accounts most people have is their 401(k) and it’s impossible to ignore if you need to make larger purchases. But is it a bad idea to take out a 401(k) loan?
Let’s first start with the mechanics of a 401(k). Generally speaking, retirement accounts will have penalties and/or taxes that you need to consider when you take money out of the account to spend. For the 401(k) and other employer-sponsored retirement accounts, they often give you the option to take a loan from the 401k. There might be limits to the amount you can take, but you have the ability to take money out while avoiding the taxes and penalties if the loan feature is available.
Like everything else, there’s never a right or wrong answer, but there is general guidance that we provide to people. In this case, we will usually try to dissuade people from tapping into their retirement money because that will likely hinder their long-term growth. We want that money to be there when it comes time to retire, and when you’re taking money out of it early, there’s less opportunity for growth over time.
But we know that emergencies happen and unforeseen circumstances will arise and taking a 401(k) loan out might be your best option. If you don’t have an emergency savings set aside, tapping into the 401(k) loan might not be the worst idea because it does have some tax advantages. The thing we like to stress is don’t become reliant on that 401(k) loan to the point where you don’t build up an emergency savings.
Now, there will be interest to pay on the 401(k) loan like any other loan, but the good news is you’re really just paying that interest back to yourself. That’s not necessarily a bad thing but something to keep in mind as well.
There are a lot of moving parts here and you want to get some help with this if it’s something you are considering. Make sure you get all the necessary information before making any decision, and that’s something we’d be happy to help you with.
Here’s some of what we discuss in this episode:
• The mechanics of a 401(k) and how it works.
• Why we generally tell people this is a bad idea.
• What can go wrong with a 401(k) loan.
• How do the taxes and interest work with the 401(k) loan.
• The opportunity cost to taking a loan out of your 401(k).