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401(k) plans typically allow loans to be taken, so that investors don’t have to pay taxes or an early-withdrawal penalty on the money.

Many 401(k) plans allow loans to be taken out on the account balance, up to certain limits, and on a strict repayment schedule. Most plans require loans to be repaid in under two years, but they can give participants up to 5 years to repay a loan.

Taking money out as a loan allows participants to avoid early withdrawal penalties and taxes. If the loan is not repaid on-time, it can be treated as a distribution, however, which might cause the investor to incur taxes. Investors usually don’t fully realize the damage that loans (and early withdrawals) can do to the long-term account balance.

Due to the power of compounding interest, which is especially powerful in a tax-deferred vehicle like a 401(k), the decreased amount of money “at work”, and the opportunity cost of would-be contributions that were directed to loan repayment instead, can severely affect the ending balance of a retirement account when the participant is finally at retirement age.

Investors should perform a simple cost/benefit analysis to decide if it is really worth it to take money from a 401(k) instead of another source.