Uncommon Cents

401(k) loans drive me crazy; you immediately lose the big advantage of the 401(k), the immediate tax break, because when you borrow from your 401(k)–which is filled with pre-tax dollars–you must pay them back with post-tax dollars. Still, many people consider their 401(k) to be a kind of piggy bank for withdrawals for whatever reason.

But the danger of the 401(k) loan is not just in the loss of the tax break–it’s in the possibility of a job loss. For whatever reason, a relative of mine decided to take a loan out on her 401(k) of $7,000. She was about 1/3 through repayment of the loan when the job ended because the company folded. This leaves her in a bind–pay the loan back immediately [which she can't do--and pretty much no one with a 401(k) loan would be able to do--or she already would have done it] or consider it a payout rather than a loan–with the accompanying taxes and 10% penalty! For someone who is in dire straits enough financially with a loan like this and a job loss, this is devastating.

So consider more than just whether or not you can pay back a 401(k) loan if you’re on the fence about taking one; also consider whether or not your job (or your entire company) is in jeopardy. If your job goes away, the loan might too–not in the sense that you don’t owe on it anymore, but in the sense that it becomes income, and usually not in the way you want.

Tags: 401(k)s and equivalents, Debt, Social aspects, Taxes

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