The majority of 401(k) plans (86.3%) allow
participants to take loans from their plan accounts.*
But should you borrow from your 401(k) savings
if your plan allows it? Here are some points
you’ll
want to consider before taking a plan loan.
The Good
Borrowing is usually a
quick, easy process. You can request a loan for any reason (although
maximum loan amount limitations apply). While
the plan may charge a fee in connection with
the loan, the cost is typically modest.
The loan won’t affect your credit
rating. Unlike commercial lenders, 401(k) plans do not
report loan activity to credit rating agencies.
You can avoid paying interest
to an outside lender. The “interest” you pay on a 401(k)
loan isn’t going to anyone except yourself.
It’s really nothing more than additional
money you are required to put into your plan
account because you borrowed funds from it. And
the “interest rate” on a plan loan
may be low in comparison to the rates charged
by credit card companies and other lenders.
You take money off the
table. An opportunity
cost is usually associated with 401(k) borrowing
(i.e., the foregone investment returns on the
borrowed amount). However, borrowing can turn
out to be an “advantage” if returns
are negative during the loan repayment period.
The Bad
Repayments are not pretax. Unlike regular 401(k)
salary deferrals, loan repayments will come out
of your after-tax income. When the plan distributes
the repaid amounts to you, they will be taxed
again.
You’ll lose opportunities for investment
growth. Because the money you’ve borrowed
won’t be invested, you’ll sacrifice
any positive returns you might otherwise have
earned.
The Ugly
The tax bite could be
substantial if you miss payments. Missing payments will likely cause
your loan to go into default and be taxed to
you (at ordinary rates) as a deemed distribution.
You may have to pay a 10% early distribution
penalty on the amount in addition to income taxes.
The plan may require you
to pay off the loan quickly if your employment
terminates, voluntarily or otherwise. Many 401(k) plans call for repayment
within 90 days of separation from the employer.
Failure to repay within the required time frame
causes the outstanding balance to become taxable,
and the 10% penalty also would apply unless you
qualify for an exception.
Like other financial decisions, you’ll
want to weigh the pros and cons in view of your
personal situation before you commit to a 401(k)
plan loan. 
