While taking a loan from your retirement savings may be preferable to cashing out, the dangers of borrowing from your 401k are a serious threat to your retirement dreams. While they are actually a good deal, especially as loans go, the effect on your retirement savings can be devastating.
Not every employer offers this as an option with their plan, but the ones who do are generally set up the same way. You will pay a very low interest rate and what you do pay will go back into your account. You can borrow up to $50,000, or 50% of your account balance, whichever is lower. You will have five years to finish repaying the balance.
So far, all of this sounds like a pretty great deal as far as loans go, and it is really! But there are dangers borrowing from your 401k, and too many people fall prey to them.
To understand the consequences of some things you need to understand that when you cash out from your account you have to pay a penalty. This consists of both federal and state taxes, plus a ten percent early withdrawal penalty. Depending on your tax bracket this can easily add up to thirty to forty percent.
As stated above you have five years to repay the balance. If you fail to repay the balance in that time then what is left is treated as though you cashed out in the first place.
If you lose your job before finishing repayment, it is also treated as though you cashed out in the first place. Of course few people plan on this happening, but are you really sure that you won’t end up quitting for a better opportunity sometime within the next five years?
For all of these reasons, and more, it’s best to look into other options and carefully consider the dangers of borrowing from your 401k before taking out a loan from your account.