401K Loan - Is it the Right Choice?

By Beth Lyons
If you are like most Americans, you know at least one friend who has lost their job in this tough economic time. Even people who are lucky enough to still be working have suffered pay cuts, layoffs and pay freezes. So when financial advisers tell us to get rid of debt, how do we do it? Many people think of their 401k. The money is

sitting there and under most 401k plans, the worker can borrow against the account. It is an option but is it the right option? Let us explore.

The 401k Rules For a Loan
Most 401k plans have a provision for allowing a loan against your retirement account. The rules are fairly straightforward (at least in most plans). You can

borrow up to 50% of your vested account balance. Or, if you have that much, $50,000, whichever is less. For payback, you usually have a maximum of five years to repay the loan, unless you are borrowing for a first home, then the government allows a longer payback.

On the Plus Side
There appear to be some advantages to taking a loan against your 401k. First, for many people is that there is no credit check on the loan. Even if you have good credit, you don't necessarily want another inquiry showing up on your report. That is understandable. Also, the interest rate is usually low. In fact, it might be the lowest interest rate you have (or would have). So taking a a $5,000 credit card debt with a 18% interest rate and paying if off with a 401k loan at 8% seems like smart money maneuvering.

On the Minus Side
If you ask me, the minuses far out weigh the pluses. Where to begin? First: if you lose your job, or leave it voluntarily, you owe the loan back right away. Yes, no more five years to pay it back. You have (for most plans) 60 days to pay back the loan. Can you honestly say that your job is secure? Do you know, for a fact that you won't be changing jobs or cities in the next five years? Everything is so uncertain these days, why take the risk? Second, you are taking money from your future to pay for the present. Don't do it. Even if you want to use it for a first home, the benefit is negligible. These are the years when you need to be putting as much as possible into retirement. The stock market is recovering and every penny you put into retirement accounts will reward you tenfold or twentyfold in 50 years. The longer you delay retirement savings the less you will benefit.