It might be tempting to borrow against your 401(k), but have you ever thought of the real cost of that loan?
Here are 5 reasons why you shouldn’t borrow from your 401(k)
1. You’re likely to reduce or stop your contributions during payback. Almost half of people who do a 401(k) loan reduce how much cash they stash for retirement while they’re repaying the loan. That’s because they’re struggling to make those payments back. And worse still, a third of people end up stopping contributions completely during their repayment time.
2. The ‘Hey, I’m paying myself back’ rationale isn’t so straightforward. When people do a 401(k) loan, they tend to justify it by saying, ‘Well, it’s my money. I’m paying myself back.’ But the thing is, you pay yourself back with after-tax money that then will be taxed again when you retire!
3. If you do it once, you may do it again. Once you take out your first 401(k) loan, what are the odds you’ll do another? Half. You have a 50/50 chance of this being a case of wash, rinse and repeat, according to Fidelity.
4. The real cost is opportunity. Taking the long view, the stock market has a lot more up years than down years. So if you’re not as invested in the market because you’ve reduced or stopped your contributions during payback, you’re missing a lot of the gain that takes place over time. That’s the idea behind ‘opportunity cost.’
5. The net effect is less for you in retirement. A 401(k) loan today means an enormous reduction in what you have to live on in retirement. So you’ll either have to work more years to make up for it or live a life that could put you in near-poverty during retirement.
So look at all the angles: You reduce your contributions, you pay yourself back with after-tax money that then will be taxed again when you retire and a lot of people contribute nothing during that time period they pay back that loan.
Read more: 5 steps toward early retirement