Why borrowing from your 401(k) to pay debt is a bad idea

Life happens. Such a simple, cliché saying, and yet it is true in ways that can be quite aggravating. Say that you have been responsibly contributing funds to your 401(k) account for years. Then, as it inevitably does, life happens. Due to an accident, unexpected medical expenses, loss of income or some other life event, you suddenly find yourself bogged down by credit card debt, student loans, mortgage payments, medical bills or some other pressing expense. And in that moment, borrowing against your 401(k) may seem like a very tempting idea, despite the fact that you worked hard over a period of years to save that money.

Sometimes it makes sense to borrow against your 401(k) to pay down debt, but more often than not, it is a bad idea. Why? Your 401(k) is protected in a variety of ways due to society's interest in your retirement savings. As a result, should you have to file for bankruptcy due to your unexpected life event and resulting debt, your 401(k) will likely be protected from that process.

Your 401(k) is protected precisely because it will help you avoid significant financial troubles in your later years. It is therefore often best to consult an experienced attorney about what changes you can make to your financial situation now in order to regain your footing without devastating your retirement funds.

Partially due to misinformation, one in four Americans has borrowed against their 401(k), according to a recent study. If these consumers had realized that this money is generally protected in the event of bankruptcy, they may have made different decisions. Please consider your long-term future before you borrow against your 401(k).

Source: KARE11.com, "Knowing about borrowing from your 401(k)," Jan. 24, 2013