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The financial media has coined a few pejorative phrases to describe the pitfalls of borrowing money from a 401(k). Some members of the financial press would even have you believe that taking a loan from a 401(k) plan is an act of robbery committed against your own retirement. However, this idea may be more urban myth than reality. According to a study by the Employee Benefits Research Institute (EBRI), nearly 20% of all 401(k) participants had plan loans outstanding. This statistic has held true since the early 2000s. Clearly, these loans have a following and, in fact, they can be appropriate in some situations. Let's take a look at how such a loan could be used sensibly and why it need not spell trouble for your retirement savings (For related reading, see Eight Reasons To Never Borrow From Your 401(k).)

When a 401(k) Loan Works
When you must find cash for a serious short-term liquidity need, a loan from your 401(k) plan probably is one of the first places you should look. Let's define "short-term" as being roughly a year or less. Let's define "serious liquidity need" as not including a sudden yearning for a 42-inch flat-screen TV.

Why is your 401(k) an attractive source for such loans? It can be the quickest, simplest, lowest-cost way to get the cash you need. Receiving a loan is not a taxable event unless the loan limits and repayment rules are violated, and it has no impact on your credit rating. Assuming you pay back a short-term loan on schedule, it usually will have little impact on your retirement savings progress. In fact, in some cases, it can even have a positive impact. Let's dig a little deeper to explain why. (If you are unfamiliar with how 401(k) loans work, a useful overview can be found in the article .)
401(k) Loan Basics
Technically, 401(k) loans are not true loans, because they do not involve either a lender or an evaluation of your credit. They are more accurately described as the ability to access a portion (usually the lesser of 50% or $50, 000) of your own retirement plan money on a tax-free basis. You then must repay the money you have accessed under rules designed to restore your 401(k) plan to approximately its original state, as if the transaction had not occurred.

Another confusing concept in these transactions is the term "interest". Any interest charged on the outstanding loan balance is repaid by the participant into the participant's own 401(k) account, so technically this also is a transfer from one pocket to another, not a borrowing cost or loss. As such, the cost of a 401(k) loan on your retirement savings progress can be minimal, neutral, or even positive, but in most cases it will be less than the cost of paying "real interest" on a bank or consumer loan.

Four Reasons to Borrow From Your 401(k)
The top four reasons to look to your 401(k) for serious short-term cash needs are:

1. Speed and Convenience - In most 401(k) plans, requesting a loan is quick and easy, requiring no lengthy applications or credit checks. Normally, it does not generate an inquiry against your credit or affect your credit rating. Many 401(k)s allow loan requests to be made with a few clicks on a website, and you can have a check in your hand in a few days, with total privacy. One innovation now being adopted by some plans is a debit card through which multiple loans can be made instantly in small amounts.
2. Repayment Flexibility – Although regulations specify a five-year amortizing repayment schedule, for most 401(k) loans, you can repay the plan loan faster with no prepayment penalty. Most plans allow loan repayment to be made conveniently through payroll deductions (using after-tax dollars). Your plan statements show credits to your loan account and your remaining principal balance, just like a regular bank loan statement.