The Dangers Of 401k Loans And Your Retirement

Dangers Of 401k Loans And Your Retirement

The dangers of 401k loansIf you are in a financial bind, seeing the money sitting in your 401k retirement account can be tempting. It is a tempting source that you may consider tapping in order to help alleviate some of your financial problems. However, your 401k retirement plan is there to be your safety net in retirement. Your 401k is not designed to be your emergency fund now. It may seem like it is not a big deal because you are essentially borrowing the money from yourself with interest, but it does not really work that way.   There are dangers of 401k loans. Here are some dangers of why you should avoid taking a loan from your 401k retirement plan.

You Must Repay Your 401k Loan

When you take out a 401k loan from your retirement plan, you must repay it. Defaulting on the loan can have serious tax consequences that can erode all of your hard work that took years to build up. Your employer is required to treat your 401k loan like any other loan or financial agreement. You must set up a repayment plan that starts immediately after taking the loan. Many 401k retirement plans now prevent future contributions to the 401k until the loan is repaid. This prevents you from continuing to grow your money and can serious degrade your future earnings that you will not be earning on the money you borrowed and on any contributions you are not allowed to make while you repay the loan. If you are lucky, you will still be allowed to contribute money to your 401k plan while repaying the loan. Or, you could consider forgoing contributions in favor of early loan repayment.

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Your 401k Retirement Plan Is Not An Emergency Fund

Your 401k Retirement Plan Is Not An Emergency Fund

Your 401k retirement plan is not an emergency fundRecently, one of my coworkers asked my opinion about taking out a 401k loan to help replace a blown engine in his wife’s car. This is a horrible idea. Your retirement plan is not an emergency fund.

Car troubles, uninsured medical expenses, house renovations, and other everyday items are not great uses for money that you have invested in your retirement fund. You should not use your 401k as an emergency fund.

It was not designed for that, and you potentially ruin the benefits that the retirement plans were designed to give you. Some studies estimate that as many as 28% or more 401k retirement plan holders have taken out loans against their 401k plans.

Your 401k Retirement Plan Is Not An Emergency Fund

Ruins Future Earnings

Many people think that borrowing money from their 401k retirement plans is no big deal because they are simply paying themselves back with the interest on the loan. While that is true, borrowers are missing out on compounding interest that that loan amount would have produced over the life of that investment while it is not in the account.

One of the biggest mistakes I made was borrowing about $10,000 from my 401k retirement plan after only having graduated from college for five years. I paid back my loan with interest over a three year term. But, not only was my $10,000 not earning interest during those three years.

That interest does not compound over the course of my future career. And, after just five years out of the gate from college, I have probably another good 40 years of work in my future before I fully retire.

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