Borrowing from your 401(k) during your starting-out years represents one of the most detrimental financial decisions for long-term wealth building. At this life stage, compound returns have maximum time to work in your favor, and any interruption carries exponential consequences.

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While 401(k) loans may appear appealing—typically offering interest rates around prime rate + 1% and allowing you to “pay yourself back”—this perspective overlooks several critical drawbacks:

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1. Lost Market Growth: You lose potential investment gains on borrowed funds during the loan period. For example, if the market returns 10% annually and your loan interest rate is 5%, you’ve effectively lost 5% in compounded growth.

2. Double Taxation: You repay the loan with after-tax dollars, even though your original contributions were made pre-tax. Later, withdrawals in retirement are taxed again, resulting in double taxation.

3. Job Separation Risk: If you leave your employer (voluntarily or otherwise), most plans require full repayment within 60 days. Failure to repay converts the loan into a taxable distribution, plus a 10% early withdrawal penalty if you’re under 59½.

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For someone in their 20s or early 30s, losing even $10,000 from a 401(k) could mean sacrificing over $100,000 in future retirement savings due to lost compounding potential.

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Use this borrowing option only in genuine emergencies, when no other alternative exists.

Additional 401(k) Resources:

• How a 401(k) Loan Works (NerdWallet)

• Borrowing From Your 401(k): The Risks (Fidelity)

• IRS: 401(k) Loans and Hardship Distributions