Pros and Cons of 401k Loans


The 401k plan has become a very popular option for retirement savings in the US over the past two decades. It is a type of savings account that is specifically designed to allow contributors to save income without having to pay for taxes on their savings until the day they retire. However, according to some studies and reports, the general state of retirement readiness in the country has been poor, which is why it is wise to think it out first before you take out 401k loans. Here are the pros and cons to consider:

List of Pros of 401k Loans

1. They are tax-free.
This type of loan does not accrue penalties for early withdrawals or income taxes. However, if you default because of unexpected circumstances, penalties can accrue quickly, which can put you into a further financial strait.

2. They are self-serving.
Though you are required to pay back 401k loans with interest, you are actually paying to yourself, so you can save the money you pay in interest. Basically, it will eventually become part of your retirement package and savings under the plan.

3. They promise fast approval.
In most cases, 401 k loans are always approved quickly, not to mention that you will also have easy access to them. Because you will be borrowing your own money, funds would be released from the lender for almost any reason, whether it is for a car or home purchase, wedding or medical expense.

4. They do not require credit checks.
You can obtain a 401k loan without a credit check or any other complicated legal application. As you will be borrowing your own money, the possibility to get the loan is almost a certainty.

List of Cons of 401k Loans

1. They cause investment losses.
When you borrow your 401k, you are removing money that you have set aside for investment in the market. Though the loan is paid back at a later date with little interest, it is not accessible for investment during the loan period, which means that potential investment gains are forfeited.

2. They are actually taxed twice the standard tax amount.
Money borrowed against these loans are actually taxed twice, as the money that is used to pay them back comes from wages that are already taxed, and you have to pay taxes on the funds that you are going to withdraw after retirement. Make sure you know your current tax bracket and take it into consideration for the future.

3. They come with hidden costs.
A huge risk of taking out a 401k loan is when you stop working for your current employer. In this case, the loan amount will be tagged and marked due in full within a short period of time, typically two months. If you default, you will also incur tax and withdrawal penalties.

4. They do not always guarantee approval.
Though most 401k plans do allow you to borrow against them, some do not. So, it is best to discuss things first with your employer.

Now, before deciding to take out a 401k loan, consider first it pros and cons. If you do decide to go on with it, do so with absolute commitment to keeping your finances in order.