The Pros and Cons of Borrowing From Your 401(k) Plan
One of the biggest disadvantages that participants face when taking a loan from a retirement plan is that the dollars used to pay the interest on the loan from the account are taxed twice. According to Lloyd Sacks, managing director of Sacks & Associates and a certified financial planner professional, the first tax occurs when the participant earns the funds and pays income tax on that earned income.
“Then after-tax dollars are paid to the plan for the loan,” he said. “Here is where the second taxation happens: The contributions that are used to pay for the loan interest do not create basis within the qualified plan and will be taxable again when the funds are distributed, generally at retirement. This is a consequence of taking a plan loan that is often overlooked, not only by participants of 401(k)s, but also by financial planners advising their clients.”
Sacks believes that a home equity line of credit (otherwise known as a HELOC) is a better alternative to borrowing against your 401(k). “If you have available equity in your home, you may be able to take a loan from your home’s equity to qualify for your loan. The loan interest for a HELOC may be tax-deductible; therefore, from a personal finance perspective, this is much more advantageous to an individual.”
