Why a 401(k) Loan May Not Be a Good Idea

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When a participant borrows against his/her retirement plan balance, investments are sold to generate cash to fund the loan. As a result, the participant is missing out on investment returns while the loan is outstanding. Paying yourself (i.e. your 401(k) account) interest on the loan is not an investment strategy. In fact, it can be viewed as creating double taxation; i.e. the participant pays interest on the loan with after-tax dollars which are become taxable in later years when paid out of the plan. Further, if the participant terminates employment with an outstanding loan, in most cases, the loan will become due at that time and, if unpaid, then it will be subject to income tax and, possibly, an early distribution penalty.

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