The Often Ignored Obvious Problem

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Dipping into your 401(k) – is it always a bad idea?

While borrowing money from your 401(k) can be tempting, it is important to inform yourself about the potential pitfalls before you make any decision. There are situations where such a loan is prudent, but it is important to be smart about.

Two important questions:

  • How will this impact my taxes?
  • How will this impact my quality of life upon retirement?
  • Is a 401(k) loan the most beneficial financial solution for me, all things considered?

Unemployment, underemployment and sick leave / disability are three common reasons for borrowing from a 401(k). The loan is often accompanied by a complete halt in making contributions to the 401 (k).

Among those who are still gainfully employed, borrowing money from the 401(k) to make a downpayment on a home is quite common. If you borrow to make a downpayment on a home, you can hopefully see some gains as the market value of your home increases in the future. If your 401 (k) is meager upon retirement, you will hopefully be able to sell your home with a profit and find something cheaper to buy or rent. If you borrow from your 401(k) to manage day-to-day living expenses, there is no such hope. This type of borrowing is often seen among those who are unemployment, underemployment or on sick leave / disability.

Still, borrowing from your 401(k) can be the best choice in a situation where you have exhausted other more beneficial solutions. Borrowing from a 401 (k) can be better than paying dearly for unsecured credit, such as credit card debt and payday loans.

One aspect that is important to take into account is your credit score. Maxed out credit cards can cause your credit score to plummet, making future credit even more expensive. Also keep in mind that many employers check the credit score of applicants before hiring, and a low credit score can hurt your chances of finding a new job. This is one of the reasons why, in certain situations, a 401(k) loan can be a better solution than other available forms of credit.

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