Should You Tap Your 401(k) Now?

Have you ever taken a loan from your 401(k)?

If you have, you're not alone. A number of studies in recent years have shown that about a fifth of 401(k) plan participants have loans outstanding at any given time. And while 401(k) loans are a once-in-a-lifetime event for some, many other folks treat their retirement savings as yet another revolving line of credit.

Ever helpful, our friends in the financial industry have spotted this trend and responded to it, with products that -- for a fee, naturally -- make taking 401(k) loans simpler than ever. Products like ReservePlus, for example, which in essence designates part of your 401(k) as a revolving line of credit, holding it in a special (high-fee) money market fund for you to draw on at any time, without cumbersome paperwork.

For the ultimate in simplicity, there's even a debit card. Now you can blow a hole in your financial future from almost any ATM machine in the world, with no extra phone calls or cumbersome paperwork required.

Can you tell I'm not a fan?

The perils of 401(k) loans
A while back, I mentioned that spending a few days in a 401(k) call center opened my eyes to the pervasiveness -- and dangers -- of 401(k) loans. Many plan participants -- too many -- have 10% or more (sometimes much more) of their balances out on loan at any given moment. And while that money is out on loan, it's not in the market.

Given the long-term powerhouse stocks that drive much 401(k) investing, taking your money out of the market the way you'd tap a home equity line is just not in most folks' long-term interest. Consider the gains you might have missed over the past five years from taking these perennial blue-chip stars out of your 401(k) portfolio:

There's just too much to lose from taking your 401(k) money away from funds that hold stocks like these.

So when should I take a loan?
All that said, the 401(k) loan is a tool that has a place in your financial toolbox. Not a tool to be used casually, for sure -- not for a new widescreen TV or a dream vacation or even a kitchen renovation. But a tool that in certain cases might be the appropriate tool for the job.

Which cases? Simply put, whenever the alternatives, after a full consideration of the costs of the loan, are even worse. If an unexpected major expense has you in a serious hole -- if your house is in danger of being foreclosed on, for example -- then by all means take a 401(k) loan if it's the best option you have. Assuming you're employed, it's a much better option than a hardship withdrawal, and certainly better than losing your home.

But absent an acute emergency, 401(k) loans rarely make sense -- unless the loan is part of a larger approach to addressing chronic problems with your finances. If you're deeply in debt, have a roughed-up credit rating, and are working with a credit counselor to get back on your feet, a 401(k) loan might be the most cost-effective debt-consolidation option available to you. But if the loan is just going to be one more debt on an ever-increasing pile, it's a really bad one to choose. Work on a budget that will keep you spending less than you earn instead, and keep your retirement savings at work for your future.