Ben is the Retirement and Investing Editor for Forbes Advisor. With two decades of business and finance journalism experience, Ben has covered breaking market news, written on equity markets for Investopedia, and edited personal finance content for B.
Ben is the Retirement and Investing Editor for Forbes Advisor. With two decades of business and finance journalism experience, Ben has covered breaking market news, written on equity markets for Investopedia, and edited personal finance content for B.
Ben is the Retirement and Investing Editor for Forbes Advisor. With two decades of business and finance journalism experience, Ben has covered breaking market news, written on equity markets for Investopedia, and edited personal finance content for B.
Ben is the Retirement and Investing Editor for Forbes Advisor. With two decades of business and finance journalism experience, Ben has covered breaking market news, written on equity markets for Investopedia, and edited personal finance content for B.
Updated: Nov 3, 2022, 1:22pm
Editorial Note: We earn a commission from partner links on Forbes Advisor. Commissions do not affect our editors' opinions or evaluations.
Getty
If you find yourself in a financial crunch, you might consider borrowing from your 401(k). Trouble is, while a 401(k) loan could be faster and cheaper than other types of credit, you could also be jeopardizing your retirement goals.
Before you take out a 401(k) loan, it’s important to know the pros and cons—and possible alternatives—so you can make an informed borrowing decision.
When cash is tight and options are few, a 401(k) loan can help you quickly bridge a financial gap—and with notable benefits. Not only do you get to borrow from yourself and pay yourself back with interest.
You can keep contributing to your 401(k) while you pay the loan back—an option that may not be available if you take a hardship withdrawal.
Since you’re borrowing money from yourself, there’s no exhausting loan application to take out a loan from your 401(k).
While you’ll need to provide some basic information to your plan administrator, it’s not nearly as much as you’d need to give a bank. The caveat? If you’re married, some 401(k) plans require spousal approval on loan applications.
While hardship withdrawals from a 401(k) get taxed as ordinary income and come with a 10% early withdrawal penalty, loans don’t suffer the same fate. You’ll generally avoid taxes and penalties if you borrow from your 401(k).
One exception is if you default on your loan. In that case, you’ll pay the penalty and taxes if you’re under the age of 59 ½.
You’ll still pay interest on a loan from your 401(k), but you could save compared with interest rates at traditional lenders. A bonus? The interest you pay goes into your account instead of your bank’s coffers.
Borrowing from your 401(k) rarely comes with an inquiry into your credit report, and loans aren’t reported to the three major credit bureaus.
If you’ve found qualifying for traditional loans difficult because of your credit score, a credit check-free loan from your 401(k) could be a saving grace.
Just as your 401(k) contributions get auto-deducted from your paycheck, so are your loan repayments. Putting your payments on autopilot keeps your loan current and more of your money working in the market.
While it’s pretty simple to borrow from your 401(k), that doesn’t mean it’s a process without its pitfalls. When available, loans from a 401(k) have limits, rules and a few quirks.
Unfortunately, not all 401(k) plans enable loans. A short conversation with your benefits department or plan administrator can explain your plan’s loan policy.
Even if you can borrow from your 401(k), the IRS sets loan limits. At present, you can borrow up to 50% of your vested account balance or $50,000—whichever is less. Some plans offer exceptions if you have a vested balance of less than $10,000, but it’s not the norm.
Of all the debt types that get discharged during bankruptcy, 401(k) loans aren’t one of them. If you file for bankruptcy, you’ll still have to repay your 401(k) loan or face taxes and early withdrawal penalties.
If you leave your job, willingly or not, your 401(k) loan will convert to an accelerated repayment schedule. Depending on your plan, you may need to pay the funds back soon after your severance date.
If your plan doesn’t have a repayment plan specific to departing employees, you’re bound by IRS rules. You’ll still need to repay your loan balance in full by tax day the following year.
Any time you pull your money out of the market, you’re missing out on potential gains and the magic of compounding returns.
If you took out a one-year, $15,000 loan from your 401(k) on Jan. 1, 2021, with a 4.25% interest rate, you would pay back $15,347. If you’d left the money invested in an S&P 500 index fund instead, then you would have $19,034 in your account. Taking out a loan means that you would missed out on a more than $3,800 return.
Before you take out a loan from your 401(k) and potentially jeopardize your retirement savings, it’s important to explore other options.
A personal loan could help prevent the opportunity cost of pulling your money out of the market. While your application will be more in-depth, many online lenders like SoFi and Marcus by Goldman Sachs offer lightning-fast qualifications and display your interest rate without a hard credit pull.
If borrowing from yourself sounds attractive, you may be able to use your home equity instead of a 401(k) to access the cash you need. A home equity line of credit (HELOC) or home equity loan can offer a competitive interest rate and more flexible loan terms.
If you qualify for a HELOC, you can also draw on those funds again once you’ve paid the line back in full—you won’t even have to re-qualify.
If you’re eyeing a 401(k) loan to repay high-interest debt, consider debt counseling. Unlike predatory debt relief services with astronomical costs, credit counselors are nonprofit organizations with low fees and potentially big impacts across your financial life.
These counselors will work with you and your creditors to establish repayment plans. They can also help you build better money management habits to prevent future run-ins with overwhelming debt.
While it’s rarely wise to raid your retirement savings, there can be times when it makes sense to use your 401(k) for a much-needed loan.
And whether you end up borrowing from your 401(k) or not, you now know how these loans can impact your finances—along with the alternatives.
Get In Touch With A Pre-screened Financial Advisor In 3 Minutes
Looking For A Financial Advisor?
Get In Touch With A Pre-screened Financial Advisor In 3 MinutesVia Datalign Advisory
Was this article helpful?
Share your feedback Send feedback to the editorial team Thank You for your feedback! Something went wrong. Please try again later.
By Taylor Tepper
By David Rodeck
Income Funds Of 2024" width="618" height="350" />
By Barbara Friedberg
By Barbara Friedberg
By Michael Adams
By David Rodeck
Information provided on Forbes Advisor is for educational purposes only. Your financial situation is unique and the products and services we review may not be right for your circumstances. We do not offer financial advice, advisory or brokerage services, nor do we recommend or advise individuals or to buy or sell particular stocks or securities. Performance information may have changed since the time of publication. Past performance is not indicative of future results.
Forbes Advisor adheres to strict editorial integrity standards. To the best of our knowledge, all content is accurate as of the date posted, though offers contained herein may no longer be available. The opinions expressed are the author’s alone and have not been provided, approved, or otherwise endorsed by our partners.
ContributorE. Napoletano is a former registered financial advisor and award-winning author and journalist.
© 2024 Forbes Media LLC. All Rights Reserved.
Are you sure you want to rest your choices?The Forbes Advisor editorial team is independent and objective. To help support our reporting work, and to continue our ability to provide this content for free to our readers, we receive compensation from the companies that advertise on the Forbes Advisor site. This compensation comes from two main sources. First, we provide paid placements to advertisers to present their offers. The compensation we receive for those placements affects how and where advertisers’ offers appear on the site. This site does not include all companies or products available within the market. Second, we also include links to advertisers’ offers in some of our articles; these “affiliate links” may generate income for our site when you click on them. The compensation we receive from advertisers does not influence the recommendations or advice our editorial team provides in our articles or otherwise impact any of the editorial content on Forbes Advisor. While we work hard to provide accurate and up to date information that we think you will find relevant, Forbes Advisor does not and cannot guarantee that any information provided is complete and makes no representations or warranties in connection thereto, nor to the accuracy or applicability thereof. Here is a list of our partners who offer products that we have affiliate links for.
