During a monetary problem or some sort of emergency, you might be tempted to break your saving plans and take some money from your 401(k) plan. People might consider applying for a 401(k) loan to get access to emergency funds instead of thinking of other options like a personal loan or credit cards. While applying for 401(k) loan might be pretty simple, but it is not recommended by most financial advisors.
1. What is a 401(k) loan?
The scheme of 401(k) loans could be defined as the disbursement of funds that you might have been saving for your retirement. You would have to repay the amount of money that you take as the loan along with the interest. At a time, you would be allowed to borrow about 60-80% of your total savings.
One might think that applying for a 401(k) loan is a good idea as the interest charges would enter your retirement funds. Since it is your own money, there would be no loan repayment issues such as loan credit or facing your creditors.
2. Why should you not consider taking 401(k) loans?
Though there might be several advantages for taking 401(k) loans but there are downsides for taking up one as well. Here are some disadvantages that you might have to face after borrowing money under a 401(k) loan.
3. Your retirement funds would be affected
Taking 401(k) loans might hinder the growth of your retirement funds as you would not be gaining any interest on the sum of money that you have taken out as a loan. Also, this scheme would prevent you from making any kind of contribution to your account while you are repaying your loan. When you borrow money from your 401(k) retirement fund, you would stop receiving compound that you might have been receiving till then. Though the borrowed money has low-interest return rate, you would be missing the initial high-interest rate for your 401(k) account.
4. It might affect your paycheck
Another disadvantage of applying for a 401(k) loan would be that your paycheck amount will be lesser every month. The primary reason for the deduction in your paycheck would be due to your loan repayment. There are families that depend on the monthly salary check for managing the expenses which include house mortgage, monthly payment bills and taxes. Taking a 401(k) loan is not recommended in this case.
5. Termination of job might create more problems
If you are terminated from your job then you would have to pay the full payment before your last day. In such cases, you would have to pay the remaining amount of the loan money within the last 60 working days of your job. The situation might become difficult depending upon the remaining money you might have to pay for your 401(k) loan scheme.
From this article, you might be able to understand why it is important to look out for other options before opting for a 401(k) plan. Another important point to be considered is that this scheme should be reserved as a last resort for a situation where you have no other option than to break your retirement fund.