Pitfalls of Borrowing from Your 401(k)

Choosing the right investment can dramatically help your 401(k) account to grow faster. But there is one more choice that you may have to make that’s just as important to its continued healthy development, and that’s allowing it to. Most plans permit you to borrow against your account balance for compelling circumstances. But those compelling reasons may reduce the amount that you’ll be able to draw someday from your 401(k). If retirement, early or otherwise, is your dream, you can’t view your 401(k) just another liquid savings account.

Some financial experts encourage borrowing from your 401(k). They’re convinced that these plans are the perfect source of funds to pay for major expenditures that crop up during your lifetime. Many people, for example, borrow from their retirement fund to pay for their children’s education.

Despite the advantages of borrowing from your 401(k), it can be a major detriment to your retirement planning. Statistics show that working women over the age of 25 change jobs roughly every five years. Job changes such as this have a significant impact on the growth of retirement plans. If you leave your job (whether due to your choice or your employer’s), you’re obligated to repay any outstanding loans; some plans require repayment within 30 days. Failing to pay the loan back would likely be viewed as an early distribution from your account and therefore be subject to a ten-percent penalty.

Also, you should bear in mind that you may not be eligible to participate immediately at your new place of work. Many companies don’t allow new employees to participate in their 401(k) plan for at least one year. That’s one full year of building toward your retirement that’s gone down the tubes, and that opportunity is extremely difficult to make up for. On a positive note, more companies have reduced or eliminated the waiting period to enroll in their plans.

Although you‘re always vested for the funds that you have contributed into the plan, it’s likely to take a while before you’re fully vested for your employer’s contributions. You might have to wait five years or longer before you reach that status, which is even more time taken away from growing your account at full strength. Before taking a different job, you should consider how much you could lose from your 401(k).

Before you borrow money from your retirement plan, stop and remember that it is your retirement plan. That’s what it’s there for. Every time that you take money away from it, you throw away the most precious commodity that there is in retirement planning -- time. The more time that you give yourself to build your retirement nest egg, the more likely you are to reach your financial goal and provide yourself with the type of lifestyle that you desire. If borrowing from your 401(k) is an absolute necessity, then by all means, go ahead and do it. But don’t do it without exploring every other alternative beforehand. Remember, it’s likely to cost you.