Using a 401(K) for Debt Reduction

One all too common form of debt reduction being used today is borrowing against a 401(k). Sure, by consolidating your credit card debt with a loan against your 401(k) you’ll be able to reduce your interest rates, but in many cases, it is still far from a savvy financial or personal decision. Here’s why:

1. You lose tax-free, compounding interest dollars on the amount you borrow. The potential gains one can realize when the money is left alone to accumulate interest without being taxed are oftentimes significant. The average $10,000 deposit in a 401(k) grows to over $14,000 after just 5 years, assuming you realize 8% gains annually, which is very realistic. If you allow the interest to accumulate for longer, the real and percentage gains are even more substantial.
2. If you are fired or offered a better position elsewhere, you will most likely be required to pay the full loan balance immediately. If this isn’t possible, you will be stuck with high fees and tax obligations, even further diminishing your potential gains.
3. There are a myriad of debt reduction options available for you to take advantage of instead. In light of the two aforementioned downsides of borrowing against a 401(k), this is extremely important to remember. After all, borrowing against a 401(k) would make a lot of sense if you had a lot of high interest credit card debt and it was the only debt relief solution available. With other options for debt reduction available, however, it is logical to explore your other alternatives.

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