No Absolute Ban on Tapping 401(k)

401kMYTH: It never makes sense to borrow from your 401(k).

REALITY: If you can avoid borrowing against your retirement plan, by all means leave it alone. But a couple of studies conclude that it can make financial sense to take a loan from it in instances other than an emergency or a down payment on a first home.

There can be gains to be had by borrowing against 401(k) assets instead of from other sources, according to separate studies by the Federal Reserve System’s Board of Governors and the Michigan Retirement Research Center.

The Fed study suggests consumers might be able to save hundreds of dollars a year by paying off debt from credit cards or auto loans. The authors analyzed average debt figures and estimated that households with access to 401(k) loans in 2004 could have saved about $3.3 billion by shifting high-interest debt to 401(k) loans. That’s about $200 per household.

The Michigan paper from last September, meanwhile, concludes that consumers might save more if they felt less cash-constrained because they’d borrowed from their 401(k) loans.

Still that doesn’t mean you should rush to borrow from your 401(k). The amount that you borrow, and any contributions that you skip during the length of the repayment will miss out on the potential growth in the market and compounding of interest over time. Also, if you change jobs you will likely have to repay the loan immediately. If you take out a long-term loan you’re essentially tying yourself to that job. Yet there are responsible ways to borrow from your 401(k). You have to look at more than just the attractive interest rate terms. Don’t be fearful of borrowing if the numbers make sense for you.

Source: The Associated Press.