Withdrawal or Borrow from 401k?

Are you considering a major purchase such as a vehicle or new home? Maybe you are looking to pay off your credit cards or make the next college tuition payment. Many people ask if they should take a withdrawal from their 401k to make these purchases or payments. I would never recommend a withdrawal from your 401k unless it was absolutely necessary. If you withdrawal money from your 401k, not only is the money permanently gone, you will pay an early withdrawal penalty of 10% if you are under 59 1/2 years of age. You also have to claim the amount you took out on your taxes as income. This can be extremely costly.

Most employers offer a loan from your own 401k account with a low interest rate. When you make your monthly payments, the interest expense and principal go back into your 401k account. There are a few downsides:

1- If you quit or get fired, you owe the money back immediately.
2- You lose out on potential compounding. For example, if you borrow $15,000 you no longer have that $15,000 in the account making money for you.

Check first with your company to see if any restrictions apply.

If you can, do neither. Try to first pay off your debt with additional money you may have saved or use incoming money. Try to put an affordable payment schedule together to get your debt down. Another choice is applying for a home equity loan. The interest on these are very low right now and is usually tax deductible. Federal tax law allows you to deduct mortgage interest on up to $100,000 in home equity debt ($50,000 apiece for married persons filing separately).