Should I take out a 401(k) loan to pay off debt?

Written By limadu on Kamis, 03 April 2014 | 22.16

NEW YORK (Money Magazine)

Only if you can keep saving for retirement. Yes, a 401(k) loan looks like a good deal initially since the interest you pay (now about 4% to 5%) goes into your account.

One danger, though, is that you just rack up more debt.

"Moving money around is not becoming debt-free," says Gail Cunningham, a vice president of the National Foundation for Credit Counseling.

Related: No 401(k)? You have options

And if you make 401(k) loan payments in lieu of contributions, the tab can be steep.

Not only do you miss out on potential returns, but you also forgo an employer match, says Vienna, Va., financial planner Michael J. Rebibo.

Plus, saving less in your 401(k) means a higher income tax bill.

And if you quit or get laid off and can't repay the loan within 60 days, you'll owe a 10% early-withdrawal penalty (assuming you're under 59½) as well as taxes.

How a $7,300 loan can hurt a 401(k)

Tapping a 401(k) to pay off high-rate debt cuts your interest costs. But repaying the loan instead of saving is costly too.

Lower contributions	$7,650
Lost employer match	$3,825
Lost returns	$800
Loss after two years	$12,275

NOTES: Assumes 6% annual return on 401(k), 4.5% interest rate on two-year loan, 25% tax bracket, 50% employer match, and contribution reduced by the amount of loan repayment. SOURCE: MONEY calculations