When to Consider a 401k Loan

A 401k loan is a process in which an individual borrows money from the available balance in their 401k. During this process, the individual can generally borrow up to the lesser of $50,000 or 50% of the account balance. They can borrow the money and then repay it to the 401k account over time with interest. While this option is available with most 401k accounts, it is not always the best choice to pursue. Here are a few things to consider about when to choose a 401k loan. 

Financial Need

If you are in a dire need of money, this could be a good time to borrow money from your 401k. There is no point in going bankrupt when you have a large amount of money sitting in a 401k account. When you borrow money from your 401k, you need to be in desperate need of the cash. You should also explore any other options that you might have such as a home equity loan or a personal loan first. The 401k loan should be your last resort in most cases.

For example, if you are about to lose your primary residence to foreclosure, you might consider borrowing money from your 401k. If you are in desperate need of money so that you can pay for medical treatment to you or one of your family members, this would be another good time to borrow money from your 401k. 

When Not to Borrow

In most cases, you should avoid trying to borrow money from your 401k. If you are considering borrowing the money for something that is not necessarily essential, then you should most likely avoid it. For example, if you want to give your home a makeover with new furniture and flooring, this is not the best use of your 401k funds. If you want to buy a big screen TV, this is definitely not a good use of your funds. For these types of purchases, you should be able to pay for them with cash or get the money from a home-equity loan. You could also use credit cards or store financing for basic purchases like this. The money in your 401k should be reserved for retirement or for dire emergencies where there are no other options.

Consequences

If you do take out a 401k loan, you need to be aware of the possible consequences of this decision. In some cases, you may not be able to pay back the 401k loan after you borrow the money. If this happens, it will be treated as a regular 401k distribution instead of a loan. Because of this, you will have to pay taxes on the money that you borrowed at your regular marginal tax rate. In addition to this, you will also have to pay a 10% early distribution penalty on the amount of money that you borrowed from the 401k.

Besides the penalties, you will also set yourself back on retirement savings. It could take many years to undo the damage that you did with the loan.

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