Should I Take a Loan Against My 401(k)?

A common question we hear from clients is: Should I take out a loan against my 401(k)? The short answer is, it depends. Like most financial decisions, 401(k) loans come with both advantages and drawbacks, and whether they make sense depends heavily on your personal situation.

Below, we break down the key pros and cons to help you make a more informed decision.

The Pros of a 401(k) Loan

One of the biggest advantages of a 401(k) loan is that your credit score is not considered. Since you’re essentially borrowing from yourself rather than a bank, there’s no credit check involved. This also means that your payments, whether made on time or not, are not reported to credit bureaus and will not impact your credit score.

Another benefit is that interest rates are often competitive compared to other loan options. While credit cards typically carry high interest rates, a 401(k) loan may offer a lower rate than a personal loan, depending on your credit profile. Additionally, these loans are generally easy to access and apply for, since they don’t require lender approval.

That said, simplicity doesn’t automatically mean it’s the best option, which brings us to the downsides.

The Cons of a 401(k) Loan

One major drawback is how repayments are handled. In some cases, loan repayments are made with after-tax dollars, which can lead to double taxation if not structured correctly. This is especially important to watch out for if you plan to repay a large lump sum.

Another significant risk comes into play if you leave or lose your job. Most plans require the remaining loan balance to be repaid within 60 to 90 days after employment ends. If you’re unable to repay it in that window, the loan is treated as a distribution, meaning you’ll owe ordinary income taxes plus a 10% early withdrawal penalty.

There’s also the opportunity cost to consider. While the money is loaned out, it’s no longer invested in the market. This means you may miss out on potential growth and compounding returns until those funds are fully repaid.

Finally, depending on your employer’s plan rules, employer contributions may be paused while you have an outstanding 401(k) loan. If that’s the case, you could be missing out on valuable employer match dollars, essentially leaving free money on the table.

While 401(k) loans can be convenient, they are generally best viewed as a last-resort option, not an ideal loan vehicle. Before borrowing from your retirement savings, it’s wise to explore other financing opportunities and fully understand the risks involved. Protecting your long-term retirement goals should always be a top priority.

Schedule a complimentary consultation and discover how our services can help you achieve financial confidence.