| Topic - Should I Borrow from my 401k? | Education Center |
THESE DAYS, almost 90% of workers with 401(k)s can borrow from their plans for whatever purpose they choose. And, thanks to huge gains in the stock market, that puts a lot of cash at one's fingertips. It certainly doesn't make sense to use this money for luxuries like a backyard swimming pool or a new car. But does it make sense to tap your 401(k) to pay off a loan?
Typical plans allow you to borrow up to half your vested balance, but not more than $50,000. You must pay the money back, with interest, over five years. But, because you are paying the interest to yourself, it isn't an additional cost. Just think of it as forced savings. If you don't repay the loan, you will owe income tax and a 10% early withdrawal penalty.
There are two negatives to borrowing from a 401(k). First, you are giving up the tax-free compounding of the money you withdraw. Second, you are replacing pre-tax money with after-tax money. So, say you are in the 28% tax bracket. It will take $1.28 in salary to replace the $1 you withdrew from your 401(k). Not very attractive, is it?