Should you take a loan from your 401k?

Not all 401k plans allow you to take loans from your account, and those that do often only allow only for certain purposes specified in the “plan document” (ask your HR department for a copy). Loans are a double-edged sword. They can be helpful if you have a critical need to borrow money, but temporarily removing money from your account slows down your progress towards retirement readiness.  Generally, it is advisable not to take loans, but there may be exceptions if taking a loan helps improve your retirement readiness. One example that can make sense is to borrow for a down payment on a primary home, if there is absolutely no other way for you to save the money for that purpose outside of your 401k. For example, if you are only able to save for a down payment on a home by reducing your 401k contributions, and especially if that causes you to lose-out on a company match, then it can be better to maximize 401k savings and then borrow from it for that purpose.

However, be aware of the following: You pay the loan back to yourself, plus interest to yourself, with after-tax money. Technically the principal portion of the loan is not double taxed, but the interest portion is double-taxed… you pay with after-tax dollars to pay the interest portion, and then you are taxed again in retirement when you take that money out as retirement income. This means the interest portion is double-taxed, i.e. has a tax penalty. This would be the case if the loan came from a “traditional”/pre-tax portion of your 401k, whereas if you also have a Roth source, there is no double-tax on interest, but there are other potentially unappealing complications to taking loans from a Roth (ask your 401k recordkeeper for details).