Borrowing From Your 401K
Financial advisors will never advise you to borrow money from your 401(k) retirement plan, after all this is the nest egg that you will need when you stop working upon retirement. Other financial advisors will tell you borrowing a 401k loan from your own retirement account is more like an act of robbery! While it is encouraged not to ever borrow from your 401(k), there are advantages of doing so on the flip side; this is what we will explore in this article. In fact, according to a study conducted by the Employee Benefits Research Institute (EBRI), 18% of all 401(k) investors had outstanding loan balances at the end of 2006. Since 18% is a significant number, there must be some advantages to borrowing 401(k) loans that these people saw.
Let's look at some advantages of borrowing 401k loans, and how not to dig a deep hole in your retirement savings. The diagram on the left describes 401(k) loans in a nutshell. In the left side of the diagram, you are borrowing a loan from your local bank, which gets its funds from investors in the stock/commodities markets. This money in the stock market ultimately comes from mutual funds that hold 401(k) retirement money of millions of employed Americans. On the right side of the diagram, you are borrowing directly from your own 401(k) plan thereby eliminating the need for borrowing from your bank and the financial markets.
When you need liquid cash urgently for a serious short-term need, a 401(k) loan from your retirement savings would sound probable. Short-term need is defined as less than 12 months. Also, a serious cash need is something that is really urgent, and not the purchase of a 47-inch Panasonic television. A 401(k) loan from your retirement savings is a quick, cost-effective way of borrowing, and it does not create a taxable event unless the limits placed on the loan are violated and the loan is not repaid on time. Also, if you pay back the short-term 401(k) loan on time, it will not significantly impact the total growth of your nest egg upon retirement. In fact, sometimes it may even have a positive impact on your total nest egg.