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Aug 23 2010 12:00AM

Question


I am considering taking out a loan on my 401(k) plan to pay off credit cards with a high-interest annual percentage rate. Is this a bad idea?

Answer


“It can be a good idea, but there are some risks,” said Michael J. Garry, CFP®, JD/MBA, owner of Yardley Wealth Management, LLC. “Obviously, the upside is that you can pay much lower interest rates with a 401(k) loan, and you are paying the interest to yourself.

“One risk from that perspective is that it is also money you are not investing. So if the stock market does really well during the time frame, like last year, you will miss out on that. Of course, if the stock market does poorly, like in 2008, you’ll come out ahead.

“There are two other bigger risks. The first is that you will let your credit cards accumulate balances again while you are still paying off the 401(k) loan, and you will have more debt than what you started with. This is a fairly common happening — and no one thinks it will happen to them.

“The other risk is that if you lose your job or otherwise change jobs, you will have to pay the loan balance in full or the loan balance becomes income to you and you will have to pay taxes on it and maybe penalties.”

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