Finance Quick Answers
Is it a good idea to borrow from my 401(k) if I need some extra money?
Nearly 20% of all tax deferred 401(k) participants have found an easy source of credit by borrowing from their own retirement accounts. Although most plans offer loans of up to half your vested balance, this may not be a good idea.
Plan loans usually charge the prime rate plus one or
two percentage points - these days 8.75%-9.75%. Because
the interest you pay goes right back into your 401(k)
account, some employees erroneously think the money is
in effect, free.
Additionally, if you borrowed money at 9.75%, but the
money had been earning 15% in a stock fund, that 15% is
the real cost of your loan. Plus, you lose all future
compounding interest on the lost earnings.
If you quit your job or are laid off or fired, your
loan may be due immediately at a time when you can least
afford to pay it back. Plus if you are under 55, you
will have a 10% early withdrawal penalty as well.
Source: Franklin, M.B. (1999, May). Despite what you may have heard, 401 (K) loans are not free. The real cost is what you don’t earn.
Sandra McKinnon, Consumer & Family Economics Specialist, University of Missouri Extension
Cynthia E. Crawford, Ph.D., Consumer & Family Economics Specialist, University of Missouri Extension
Last update: Sunday, July 27, 2008