Some 'Insensitive' Advice on 401(k) Loans

If you are laid off, you'll have to pay it back or default. It hurts both ways.

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Suzanne Lucas
A few weeks ago, I advised readers to save money in case of a layoff. I got a few angry comments from people calling me insensitive. Whether I'm insensitive or not is up for debate, but I thought I'd go ahead and offer some additional insensitive layoff-preparedness advice: 

Do not take out a 401(k) loan. 

I know; it's tempting. You need cash. Or the value of your 401(k) has dropped so substantially that you feel as if you're entitled to some fun. (Really. I read on a message board how a bunch of people were planning to take 401(k) loans out to go on vacations because the economy was so depressing.)

These loans seem to be a nice thing: You are borrowing your own money and paying yourself interest in the process. Paying yourself seems to make more sense than paying the bank. Besides, with the stock market down, you may justify the move by saying that you will pay yourself more in interest than the money would earn if left alone. Fair enough. 

Except that a 401(k) loan is what I like to call a really bad idea. If you haven't repaid the loan when you leave your job, either voluntarily or involuntarily, you must repay it in full. If you can't do that, many of the plans give you 60 days to repay. 

Just when you've lost your job and it seems that things can't get worse, you now have to repay a loan within 60 days. Yikes! But it gets even worse. If you don't happen to have that large sum of money sitting around (because if you did, why did you take the loan in the first place?), you can simply default. 

And what does that mean? It means that you have to pay taxes on the loan, plus a penalty. Again, just when you don't have money to spare, your tax bill increases—in some cases, substantially. 

I'm not a financial planner. I've just listened to people cry about the nightmare that ensued when they lost their jobs and had their 401(k) loans called in. And although I have some leeway in helping people through their layoff, adjusting the terms of their 401(k) loan is out of the scope of any HR practitioner. 

Even if you are sure you would never get laid off (don't count on it), a 401(k) loan binds you to your current job. If you quit, the same conditions apply. Don't put yourself in a position that prevents you from taking a better job opportunity. And don't count on your current job to always be there for you. I don't think the bloodletting is over yet. I hope I'm wrong. But just in case, leave your 401(k) money in your 401(k).

Suzanne Lucas has nine years of h uman r esources experience, most of which has been in a Fortune 500-company setting. She holds a p rofessional in human resources certificate from the Society for Human Resource Management. She blogs at Evil HR Lady.