The 7 Biggest 401(k) Mistakes – #4 Taking a Loan to Payoff Debt

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401k Tips for Business Owners and InvestorsI get this question in my practice quite frequently. Should I take a loan in my 401(k) to pay down debt?

People sometimes get in over there heads. I can understand if you have a massive amount of medical bills that are threatening to send you into bankruptcy. More often, the client is asking if it makes sense to pay off credit cards, other times cars, sometimes even their children’s debts like school loans.

My opinion on this is pretty straightforward.

Your 401(k) isn’t that little pink piggy bank in your closet in your room. It shouldn’t be used for whatever you want.

Most plans don’t offer a way to access the 401(k) account while you are still working. On the other hand if your plan has loan provisions you could use that.

However, if you can’t pay it off with extended terms, what makes you think you’ll pay it back in the required 5 years in the 401(k)? Some plans offer hardship withdrawals. If your plan offers a hardship withdrawal, credit card debt, car loans, etc. do not constitute hardships. Hardships are typically things like the death of an income producing spouse.

Keep in mind this is a taxable distribution and incurs the 10% early distribution penalty. In addition, you may not be permitted to contribute to the plan for another six months after the withdrawal.

There are way too many factors working against you with a 401(k) loan or withdrawal. I go into it in way more detail in my ebook The 7 Biggest 401(k) Mistakes. You can download it for free here.