Question:   Is borrowing from 401k funds something that I should do in order to pay off my debt?

Answer:      Taking a quick and easy loan against your 401k account can be very tempting.

In fact, there is a great deal of bad financial advice out there, possibly even from your employer, that can make you think this is the lowest cost of borrowed money.

However, there are real risks associated with borrowing from your 401k that may sway your decision, even if you’ve accumulated a lot of bad credit card debt and this option appears to be a quick fix to fix bad credit.

Don’t be fooled. The risk involved in taking out a loan against your retirement account is high. Borrowing from 401k accounts rarely proves to be a wise decision. When taking out a loan against your 401k, you put yourself in danger of being in a position to have to pay back that loan in full within a 90 day window.

This can, and often does, happen to employees who unexpectedly lose their job. In the event you become unemployed, you will be required to pay back the loan within 60-90 days or the IRS will consider the loan proceeds as income earned and you will then be responsible to pay the taxes on that income during the current year.

Do you really want to risk being put into this sort of financial crisis? Nowadays, anyone can lose their job at any time. The term “job security” is a myth.

Imagine if this happened to you and you weren’t able to immediately pay off the 401k loan - you would have to take out another loan (at a higher interest rate) in order to avoid the tax consequences - but how would you qualify for the loan if you were out of work?

Not only will be forced to treat the funds as an “early withdrawal” and be accountable for the taxes, 401k withdrawal rules also ensures you’ll be charged a stiff 10% early withdrawal fee – in total, you’ll lose roughly 40% of the amount of the loan you took against your retirement.

Obviously, the risk explained makes borrowing from 401k funds look less and less tempting. Unless you are experiencing a dire financial emergency, taking out a loan against your 401k is not wise. It is however, a slightly better option for a emergency situation than taking an early distribution.

At least the interest and principle will eventually make it back into your account as you repay the loan, barring the aforementioned job loss - unlike an early withdrawal which has no plan for repayment.

Borrowing from 401k accounts also sets a bad precedent. Your 401k is meant to be a long-term investment for retirement and retirement only. You shouldn’t allow yourself the luxury of taking out a little here and there for short-term expenses.

Bottom line, follow this 401k advice and avoid the temptation to access the money. Keep your 401k, and your future retirement income safe.

Looking for ideas on how to prepare for any future financial crisis? Access this free guide, Financial Readiness In Times Of Crisis. Learn how to handle your finances in the wake of an emergency or unplanned financial hardship.

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