Your 401(k) lets you borrow from yourself. Low rate, you pay yourself back, the interest goes into your own account. Sounds great. Here are the 3 catches.
How much you can borrow
Up to 50% of your vested balance or $50,000, whichever is less, if your plan allows loans. You generally have 5 years to pay it back, longer if it’s for buying your home.
Catch 1: The money stops growing
While it’s out of your account, it isn’t invested. If the market goes up 15% that year, you missed it. You don’t get that back.
Catch 2: You pay it back with taxed money
Your payments come out of your paycheck after tax. In a regular 401(k), that money gets taxed again when you withdraw it in retirement. The interest you pay yourself gets taxed twice.
Catch 3: Leaving your job
This is the big one. If you leave for any reason, fired, laid off, or you quit, your plan can require you to pay back the whole balance.
Whatever you can’t repay gets treated as a withdrawal. That means income tax on it, plus a 10% penalty if you’re under 59½. You can avoid the tax by putting that same amount into an IRA by your tax filing deadline for that year, but you’d need the cash to do it.
When it might make sense
When the alternative is foreclosure, bankruptcy, or high-interest debt you truly can’t avoid, and your job is stable. Otherwise, your 401(k) is for retirement. Not a piggy bank.
What I actually use: Fidelity for my Roth IRA and brokerage, and the rest on my What I Use page.
General education, not advice for your situation. Loan rules vary by plan, so check your plan documents.
Leave a Reply