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401(k) Loans? They’re Typically Not A Good Idea

There is little doubt that 401(k) Plans are the way to go if you hope to have a comfortable retirement. Social Security benefits, once a retirement surety, seem to be wading in uncertain waters. Pensions, another one-time given for retirees, are swimming in similar waters. Fortunately, 401(k) Plans, which sometimes offer a matching contribution by the employer, are helping to make the monetary outlook of retirement look relatively secure again.

Even so, some people think of a 401(k) Plan as money in the bank that can be taken out at will. In theory, these people are right. Yet, taking money out before the designated time could have negative implications. Let’s look at four more-than-valid reasons why borrowing against your 401(k) is not a good idea.

1) You may not be able to put additional monies into the program until the loan is paid back.Some plans stipulate you cannot add any additional monies until the loan is repaid. Even if your employer does not have this requirement, it is still unwise because the money is in there for retirement purposes.

2) Penalty if you are not yet 59½ and cannot afford to pay the loan back when you leave your employer. If you are not at least 59½ years of age and leave a job expectedly or unexpectedly, you typically must repay the loan, oftentimes within 60 days. If you cannot afford to pay the loan back, then you will likely incur a 10% penalty.

3) Loan amount will be added as a type of income on your taxes. If you cannot pay a 401(k) loan back when you leave your job, then you may be considered in default of the loan and be required to add the amount you received as a type of income on your tax return for that year. For example, if you earned $80,000 in 2012 and are in default of a $50,000 401(k) loan, then your taxable income for 2012 could be at least $130,000 (before deductions).

4) Jeopardizing your monetary future. If you take a portion of your 401(k) money out and do not repay it, it will not be there to work for you in retirement. Retirement may seem like a long distance down the road, but chances are you will rely on that money when you are no longer working.

Okay, if there are unpleasant consequences associated with 401(k) loans, why do some people want them?

In short, they need the money. Common reasons individuals turn to this type of loan are hardship situations, the purchasing of a new home, and college tuition for the children. Still, if the loan is repaid in a timely manner, there may be few if any repercussions: actually, the interest rate on 401(k) loans tends to be appealing. Nevertheless, if repayment fails to happen, the ramifications become only too real.

For greater clarity on this topic, talk to your benefits/human resources department or a trusted financial advisor.