To most people, taking out a loan from your 401k might sound like a good idea. After all, it’s our own money you’re borrowing and you can repay yourself with interest to help enhance your overall returns right?  Well, despite conventional thinking, the reality is this method can actually do more harm than good to your future retirement plans.  Let’s look at the drawbacks and risks involved:

1)  401k contributions are made with before-tax dollars.  When you take out a loan from your 401k, you are re-paying the interest of the loan with after-tax dollars. During retirement when you’re ready to start withdrawing income from your 401k, you are taxed again on the interest you had paid to yourself. 

2)  Some people think that as long as you can earn a greater return on the amount of loan you withdrew from your 401k you can still come out on top.  However, there is no guarantee that a different method of investment can yield a higher, in fact, it could very well backfire on you.

3) If you take out a loan and then lose your job or move to a different company you will need to pay the loan back immediately.  If you don’t the loan will be considered a distribution and be subject to income tax and, if you are under the age of 55, a 10% early withdrawal penalty.

So just remember when you are considering taking out a loan from your 401k to use the funds as an investment vehicle or to finance a purchase, you might be opening yourself up to a whole new can of worms. 

 

Source: AARP