Good news: Fewer savers made this dangerous 401(k) move in the most recent quarter

(Maurie Backman)

Inflation has created a financial crisis for many people this year. So, if you’ve been struggling to cover your life’s expenses, you’re in good company.

In fact, you may have reached the point where you needed a loan this year. And if so, instead of dealing with applications at various banks and lenders, you may have been looking into your own 401(k) plan.

If you have your retirement savings in an IRA, you can’t take out a loan against your balance. But many 401(k) plan administrators allow savers to borrow against their balances.

Image source: Getty Images.

That might seem like a tempting option, since that money is actually yours. If you have to pay off a loan, you are paying it off yourself.

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However, borrowing against a 401(k) can be a dangerous thing for a variety of reasons. Thankfully, that practice appears to be on the wane.

Fidelity reports that only 2.4% of participants initiated a 401(k) loan during the third quarter of 2023. The percentage of people with an outstanding 401(k) loan was 16.7%, a nice drop compared to 18.7% of savers who had one of these loans during the third quarter of 2020.

If you’re considering taking out a 401(k) loan, you should know that it’s a move you may regret long after the fact. Here because.

Don’t take chances with your savings

A 401(k) loan might seem like a reasonable way to borrow. But if you fail to repay that loan on time, it could end up costing you much more than you anticipated.

When you remove funds from a 401(k) plan before you reach age 59½, you face a 10% early withdrawal penalty, plus tax on your distribution. If you don’t repay a 401(k) loan on time, it will be treated as a withdrawal. If you’re not old enough to make a withdrawal without being penalized, you’ll face that 10% hit by the bat, as well as being taxed on your distribution. All in all, it’s not a good situation.

Now, if you’re thinking that you’ll be super vigilant and pay off your loan on time, well, that might not happen. If you happen to part ways with your employer while you have an outstanding 401(k) loan, you usually only have a few months to pay it off before it’s treated as a withdrawal. And you may not be able to meet that timeline.

Plus, if you take out a 401(k) loan but can’t put that money back into your retirement plan, you risk a financial shortfall once your career ends. Remember, you’ll need a fair amount of income outside of Social Security to live comfortably once you stop working. So pulling a lot of money out of your 401(k) isn’t a great idea.

If you need to borrow money in a pinch, it might be worth considering a personal loan or HELOC, even at today’s higher loan rates. And if your loan is for a non-essential purpose, such as home renovations, consider holding until loan rates are more reasonable.

Chances are you’ve worked hard to throw a bunch of cash into your 401(k). So don’t let the effort go to waste by pulling out some of that cash, even if you have every intention of paying it back.

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The Motley Fool has a disclosure policy.

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