Can I Borrow From My 401k to Pay Down Debt?

Employees usually can borrow money from their 401k retirement plans to pay down their debts. The question is whether you should use your 401k funds for that purpose, because it's not a wise choice in some cases. The amount of debt you have and your career plans should influence your decision on borrowing from your 401k.

Process

Consider whether you could borrow enough from your 401k to make a significant impact on reducing your debts. Employees usually can borrow up to $50,000 of their 401k account balance, and they typically have up to five years to repay the loan. It may not be worthwhile to borrow from your 401k if you're deeply in debt and the loan would only help you repay a small portion of what you owe. In such cases, you would still have a lot of debt, and you would create another debt by borrowing from your 401k. Retirement plan providers usually take monthly deductions from employees' paychecks to repay 401k loans.

Bankruptcy

Some employees borrow from their 401k plans to avoid filing for bankruptcy, but "Consumer Reports" notes that may unnecessarily increase their financial problems. Money in 401k plans is off limits to creditors, debt collectors and others when people declare bankruptcy. Employees who still have to declare bankruptcy after using their 401k to pay debts ultimately lose money they could have retained for the future.

Money Management

You may have enough money in your 401k to pay down a significant amount of your overall debt. However, "Consumer Reports" notes that people can easily end up back in financial trouble if they don't change how they handle their finances. For instance, it's important to avoid racking up high-interest debts from credit card charges and payday loans. Otherwise, you could accumulate more bills than you had before you paid off debts with your 401k loan.

Considerations

Avoid borrowing from your 401k plan if you're concerned about losing your job or are considering a job change. People who lose or quit their jobs after borrowing from their 401k plans usually have to repay the loan in full within 60 days of leaving their employer, according to Bankrate.com. More debt accumulates if you can't repay the loan by the deadline because you will have to pay taxes and penalty charges on the remaining balance of the loan.