Why You Can't Borrow From Your 401(k) ... and the Only Way You Should

NEW YORK (MainStreet) — Anyone with a home or rental payment and a mountain of bills on top of that can relate to the temptations of borrowing from your 401(k).

The fact is, though, you shouldn't do it — at least almost never.

Not many people take a loan from their 401(k) plan. According to a recent study from TIAA-CREF, only 29% of Americans have, and of those, 44% say they "regret the decision."

"Paying off debt was the top reason for taking out a loan from retirement plan savings, cited by 46% of respondents, yet only 26% of respondents said paying off debt was a good reason to take out a loan," TIAA-CREF says. Women were more likely to take out a 401(k) loan, by a 51% to 42% margin over men.

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Pamela Yellen, a consumer financial consultant and two-time New York Times best-selling author, says the 401(k) has replaced mortgage lending as a "pricey piggy bank" with huge costs for those who borrow from their plans.

"Just because you can take a premature withdrawal or a loan from your 401(k) doesn't mean it's a good deal," she says. "The Internal Revenue Service collected $5.7 billion in 2011 from penalties, meaning that Americans took about $57 billion from retirement funds that they weren't supposed to."

Yellen adds there are many strings attached to borrowing from a 401(k) plan, including how much you can borrow, what you can borrow it for and how and when you must pay it back. "And if you leave your job for any reason, you'll typically have to pay the loan back in full, with interest, within 30 to 60 days or you'll owe taxes and penalties," Yellen says. "And you thought it was your money!"

Here's how a 401(k) loan can set you back financially, in ways you probably haven't considered.

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If you take out a loan from your 401(k) and can't pay it back, you'll be on the hook for taxes with the IRS, plus get socked with an extra 10% penalty if you're younger than 59.5, the age at which you're allowed to make an early withdrawal. "In most cases you're required to pay your loan back in full with interest in 30 to 60 days, or you'll have to pay income taxes on the money you borrowed plus a 10% penalty," Yellen says.

If you absolutely have to take out a loan out to prevent against a financial catastrophe such a home foreclosure or from having your car repossessed, go ahead — just make sure you structure the loan in a way you can manage to pay it back, avoid denting your 401(k) plan too much and avoid IRS tax penalties.

Those situations are the exception. In the vast majority of cases, taking a loan from your 401(k) can set your retirement back years if you don't pay the loan back promptly — so it's best to avoid the temptation.

— By Brian O'Connell

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