Borrowing from 401(k) - NOT a Good Idea

Nearly 20% of all tax deferred 401 (k) participants have found an easy source of credit by borrowing from their own retirement accounts. Although most plans offer loans of up to half your vested balance, this may not be a good idea.

Plan loans usually charge the prime rate plus one or two percentage points - these days 8.75%-9.75%. Because the interest you pay goes right back into your 401(k) account, some employees erroneously think the money is in effect, free.

Additionally, if you borrowed money at 9.75%, but the money had been earning 15% in a stock fund, that 15% is the real cost of your loan. Plus, you lose all future compounding interest on the lost earnings.

If you quit your job or are laid off or fired, your loan may be due immediately at a time when you can least afford to pay it back. Plus if you are under 55, you will have a 10% early withdrawal penalty as well.

Source: Franklin, M.B. (1999, May). Despite what you may have heard, 401 (K) loans are not free. The real cost is what you don’t earn.