Taking a loan from your 401(k) "is never a good idea," says Catherine Golladay, vice president of 401(k) services at Charles Schwab.
A recent Schwab study found that nearly a quarter of 401(k) participants take loans from the retirement plans.
A quarter of those who have taken a loan from their 401(k) said they used their early withdrawals to pay everyday bills. Almost 10 percent said they used the money to "buy something special," and another 5 percent used the withdrawals for vacations, suggesting some workers may be making the withdrawals without a full understanding of the consequences of doing so.
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Not all early distributions were used as disposable cash — 23 percent used the loans for a down payment on a house, and 13 percent used the cash to pay off medical expenses.
"If you leave your job, you'll need to pay back the loan ASAP — sometimes within 30 days of leaving your employer," explained Golladay in a release, detailing the consequences of early 401(k) withdrawals.
"If you can't pay it back, you'll owe taxes on the balance and probably a 10 percent penalty as well," she added.
See also: Many repeatedly borrow from their 401(k)
Loans are paid back with money that has likely been taxed. That repayment is taxed again after it is withdrawn during retirement.
"While paying back a 401(k) loan, many people tend to stop saving in their plan," said Golladay. "This is a huge mistake and can quickly derail retirement savings, which you may or may not be able to recover from."
The Federal Reserve reported that consumer borrowing jumped 10 percent this past July, the largest increase in three years.
As Americans' appetite for borrowing appears to be increasing, Golladay reminds would-be 401(k) borrowers of an important reality: retirement assets in defined contribution plans are typically safe from creditors.
But make a withdrawal and convert the savings to cash, and creditors could come calling to collect on it.
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Nick Thornton
Nick Thornton is a financial writer covering retirement and health care issues for BenefitsPRO and ALM Media. He greatly enjoys learning from the vast minds in the legal, academic, advisory and money management communities when covering the retirement space. He's also written on international marketing trends, financial institution risk management, defense and energy issues, the restaurant industry in New York City, surfing, cigars, rum, travel, and fishing. When not writing, he's pushing into some land or water.
