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THESE DAYS, many workers with 401(k)s can borrow from their plans. And a growing portion of 403(b) plan participants can too. If you've been diligently socking away a portion of your salary over the past few years (and you've had a match to boot), chances are that puts a lot of cash at your fingertips. It certainly doesn't make sense to use this money for luxuries like a backyard swimming pool or a new car. But does it make sense to tap your 401(k) or 403(b) to pay off a loan?
Typical plans allow you to borrow up to half your vested balance, with a cap. (Some plans might restrict borrowing to specific reasons, like a home purchase, education or medical expenses.) You usually must pay the money back, with interest, over a specified period of time. But, because you are paying the interest to yourself, it isn't an additional cost. Just think of it as forced savings. If you don't repay the loan, you will owe income tax and a 10% early withdrawal penalty.
Sounds like a pretty good deal, right? Well, there are a couple of big drawbacks. First, you are giving up the tax-free compounding of the money you withdraw. That could lead to a signficantly smaller nest egg come retirement. Also, if you leave your current employer for any reason, you will probably have to pay the loan back immediately or face taxes plus a penalty.
Bottom line? Before you even consider tapping your plan, make sure you have no other nonretirement sources available to repay the loan.