Like other loans, a 401(K) loan has its own advantages and disadvantages. You are supposed to understand both the pros and cons well before you choose to take a loan from your 401(K) plan.
The pros of 401(K) loan
It is usually quick and easy to request a 401(K) loan because no application or credit check is required. You can also make the request online with several simple clicks and get your fund within a few days.
In most cases, you can repay the 401(K) loan through a payroll deduction that functions automatically. Your plan statement will present credit to your loan account and the remaining principal balance.
Retirement savings increased
When you repay the loan back to your 401(K) account with the interest, the repayments will be allocated accordingly into your portfolio’s investment. Eventually, you will repay the account a bit more than the original amount of money you have borrowed. If the interest you have paid exceeds any lost investment earnings, the 401(K) can increase the retirement savings progress.
The cons of 401(K) loan
Originally, you put pre-tax money into the 401(K) account. However, as you pay the interest back into the 401(K) plan, the interest will be regarded as after-tax money.
If you have not borrowed money from the account, you will be taxed only once when you withdraw the fund out of the plan.
Once you borrow the money out, you will have to earn the money, pay the tax, and repay the money as well as the interest back into the account. As you take the money out later, you are required to pay the income tax again. Thus, you pay double taxation.
If you do not work for your employer anymore and you haven’t repaid your loan, any outstanding balance can be regarded as a taxable distribution to you.
No bankruptcy protection
If you borrow money from the 401(K) account to pay your debts, yet you are still in financial trouble and claim bankruptcy in the end, you will have to use the 401(K) money to repay the debts. In that case, the money can no longer be used to protect you from bankruptcy after you retire.