I Know It’s a Terrible Idea, but I Really Want to Borrow From My 401(k)

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Kristy Gaunt / The Penny Hoarder

Dear Penny,

We have a student loan for about $50,000 that we incurred for our children’s college expenses. Even though I know the answer, I still wonder if it’s a good idea to take a 4% loan from my 401(k) to pay off the student loans.

My wife and I are in our mid-50s, so we could pay off the 401(k) loan before retirement. Because the payments would be paid back to the 401(k), we’d still have that money when we retire. While we’d miss out on the investment, we wouldn’t have the burden of the student loans for another 20 years.

My other concern is the volatility of the market. I’m nervous about another crash, but in that case, at least I would have used the capital to reduce my debt before losing it.

-Perplexed

Dear Perplexed,

I love that you admit to knowing the answer to your question while you ask it. But hey, I don’t blame you for asking. We’ve all done it, right? If mom says no, ask dad. If the Google consensus is no, call a friend just to be sure.

Let’s go over the basics of taking a loan from your 401(k) before thinking about the specifics of your situation.

You can borrow as much as half the balance of your employer-sponsored 401(k), up to $50,000, without penalty. You can only withdraw money you contributed to the plan, and you typically have to repay the loan within five years. If you leave your job, you’ll have to pay back the loan within 60 days or take the amount as a heavily taxed distribution.

The basics aren’t too exciting, and there’s too much wiggle room for trying to justify taking this type of loan. So I, too, decided to phone a friend: Lillian Karabaic, author of the “Get Your Money Together” workbook. She promised me plenty of opinions on taking a loan from your retirement account. And she delivered.

“If you could pay off the 401(k) loan before retirement, why would you not just pay off the student loans instead?” she said by email. “Interest rates are less important than your behavior. If you’re considering this at all, it sounds like you’re looking for the easy way out of this debt.”

Since student loan repayment terms are typically 10 years, and parental loan repayment can’t be extended, repayment will take you right up to retirement age anyway.

“There’s also nothing saying you can’t pay off that student loan early on your own,” she said. “No need to borrow from your future self to do so.”

She advised paying these loans from your income while you and your wife are still working, rather than borrowing from your eventual retirement income.

Still not convinced Karabaic doesn’t like borrowing from 401(k)s? “I’d rather see you sell your house than take out a 401(k) loan to pay off other debt,” she said.

Yikes, right?

If you’re concerned about the market, she said to consider reallocating your portfolio to focus more on bonds than stocks, which is a usually good plan as you near retirement age.

“Don’t borrow from Peter to pay Paul,” she said, “Or in this case, borrow from yourself to save Sallie Mae.”

I hope you’re feeling the weight of this peer pressure, Perplexed. Don’t let us down out there. As my college roommate used to implore before a night out: Make good choices!

The inbox is open. Submit a question or send your worries to [email protected], and I’ll see what I can do to help.

Disclaimer: Chosen questions and featured answers will appear in The Penny Hoarder’s “Dear Penny” column. I won’t be able to answer every single letter (I can only type so fast!). We reserve the right to edit and publish your questions. Don’t worry — your identity will remain anonymous. I don’t have a psychology, accounting, finance or legal degree, so my advice is for general informational purposes only. I do, however, promise to give you honest advice based on my own insights and real-life experiences.

Lisa Rowan is a senior writer at The Penny Hoarder.

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