In this edition of our Motley Fool Conversations series, Fool personal-finance expert Dayana Yochim and retirement-planning analyst Dan Caplinger discuss the allure of using your retirement savings as a way to borrow money for immediate expenses. Given the lengthy process and chance of rejection in getting a bank loan, as well as the high cost of alternative financing like payday loans or credit card cash advances, tapping your 401(k) can be very tempting as a quick source of cash.
Even though many 401(k) borrowers note that they're essentially paying interest to themselves, Dan points out that you have to use after-tax money to repay your loan, which amounts to paying tax twice on the same money. Moreover, if you have trouble paying the loan back, it'll be treated as an early distribution, incurring immediate tax liability and potential penalties. Worst of all, if you lose your job, you have to pay back your loan immediately or else faces dire tax consequences. For those workers for whom a 401(k) loan is truly a necessary last resort, Dayana and Dan offer some advice and useful tips to avoid getting yourself into credit trouble with a 401(k) loan.