Why You Shouldn’t Borrow From Your 401K

Why You Shouldn’t Borrow From Your 401K

As money accrues in your retirement account, it can be tempting to borrow from it for other uses. However, in the long term, this isn’t recommended. At Prosper Financial, we understand that when saving for retirement you might have questions–not just about how to manage the funds you are putting away, but how much money you’ll need when you retire. Our advisors can work with you to develop a plan that is appropriate for your financial needs. 

What Is a 401K And How Can You Borrow From It?

A 401(k) is a common type of retirement account. Percentages of your paycheck go into the account and, in some cases, your employer may match that contribution. Funds in the 401(k) will then be invested with the goal of helping your money grow. A financial advisor can discuss your investment options with you, but the general intent behind the investment is to manage risk and strive for monetary growth for when you are ready to retire. 

According to the IRS, you can borrow from the balance in your 401(k) before you are ready for retirement, but there are some conditions. If you choose to take money from your 401(k) before you are 59 ½ (or meet another exception), you will have to include that amount in your taxable income for the year and may even have to pay additional taxes. 

Your plan may also allow you to loan money from the value of your 401(k) through your employer. However, you’ll need to consider the terms of the loan itself, so that you can better understand any restrictions on when and how you might need to repay it. In some cases, you may be required to pay the sum back immediately if you leave the job in question. Otherwise, it will count as a withdrawal and be subject to the same tax consequences described above. 

Risks Involved With 401K Loans

If you are considering borrowing from your 401(k), it’s important to understand the risks involved. When you borrow from a 401(k), you run the risk of lowering your contributions while you pay back the loan. If your employer is matching contributions, that can amount to even more money you are losing out on. 

Additionally, if life circumstances force you to change jobs, you can run into added stressors if the change in employment causes your loan to suddenly come due. If you are unable to pay back the loan, you can potentially face penalties for the early withdrawal. Ultimately these circumstances can have negative consequences for the outlook on your retirement accounts, which is why many advisors suggest against borrowing from your 401(k). 

Retirement Planning with Prosper Financial

Understanding your 401(k) and the consequences of borrowing from it is an important part of your long term financial strategy. If you have questions, our advisors at Prosper Financial are happy to discuss your goals with you. Contact us today to schedule a consultation.