Nearly A Quarter of Fidelity's 401(k)s Have Loans Against Them

Via Felix Salmon, I see that over 20% of Fidelity 401(k)s now have loans out against them.  Since Fidelity is one of the biggest players in the space, it's reasonable to assume that this tells us something about the state of American 401(k) plans.

Felix points out that anyone who's planning to take a loan against their plan should be less heavily weighted in stocks.  This is true, but I'd like to make a different point:  you should not plan to take a loan against your 401(k).  In theory, these loans are a good deal--you pay interest to yourself!  In practice, they're very dangerous.  Leave aside concerns that you'll "miss out on appreciation" for the duration of the loan, because like many of you, I've spent the last decade missing out on appreciation even without taking any loans against my retirement accounts.  These loans can put you in a bad fix.

401(k) loans are especially tempting in a down economy like this, when it may be hard to get other kinds of credit.  Unfortunately, they're also especially risky.  If you lose your job, you're probably going to have to pay the loan off in full, immediately--or have it count as a withdrawal from the account.  If you are younger than 59 1/2, that means you'll owe income taxes on the full amount, plus a 10% penalty.  Naturally, the worst possible time to be paying those taxes and a 10% penalty is . . . when you've just lost your job.  You can probably work out a payment plan with the IRS, but the folks who handle this sort of thing at the IRS are not a merciful people, and they charge penalties and interest that would make a loan shark blush.

If a 401(k) loan is the only way to avert something truly catastrophic--foreclosure, the death of your child from an operable brain tumor--okay, go ahead.  But they are a bad idea for anything less pressing (and I include things like school tuition in the "less pressing" category).  It's all too easy to end up in a deeper hole than you were before.