It seems that some Americans have begun treating their 401(k) retirement accounts like goodie bags at a Halloween party. Last year alone, 18 percent borrowed from their 401(k) savings, according to the Employee Benefit Research Institute. Sometimes, as in the case of a true financial emergency, taking out a 401(k) loan can be your best option. But it’s also a serious decision with potentially negative consequences. So before you go dipping into your 401(k) money like it’s candy, consider how it could come back to haunt you later:
1. When you re-pay a 401(k) loan, it’s with after-tax dollars.
Unlike the money you contribute to your 401(k), the money you use to pay back your 401(k) loan comes from your after-tax income. Then it will be taxed again when you retire and start 401(k) withdrawals. Double trouble!
2. If you don’t pay a 401(k) loan back, there are steep penalties.
Loan balances that are outstanding after the loan term expires (usually in five years) are subject to federal and state income taxes and a 10 percent IRS penalty.
3. If you lose your job, you may have to pay the 401(k) loan back immediately.
Under most plans, you must pay the loan back in full within 60 days of losing your job, or suffer those tax consequences and 10 percent penalty. That’s enough to keep anybody up at night.
4. You can’t deduct the interest on your taxes.
Something you may be cursing come April 15: Unlike the interest on a mortgage or a home equity loan, the interest you pay on a 401(k) loan is not tax deductible.
5. You could lose interest earnings.
If you borrow from your 401(k) you’ll be slowing the growth of your retirement fund, because the money you borrow won’t be earning interest during that time. It might not seem like a big loss now, but you’ll feel the pain when it’s time to retire.
6. You’ll lock in your losses.
The vast majority of Americans with 401(k)s have recently seen their balances drop with the stock market. If you are thinking about borrowing from your 401(k) now, you may be “realizing,” or locking in, some of those losses.
7. Warning: borrowing from your 401(k) can be habit forming.
Many financial experts advise people to think of their retirement account as sacred, something not to be touched except in cases of extreme need. If you borrow from your 401(k) once, you might be tempted to do it again.
Beware: A professional financial adviser can help you decide if a 401(k) loan is the right strategy for you.
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