Besides taking early withdrawals for hardship reasons, an employee also can “borrow” from his or her 401(k) account in an emergency. It’s not a good idea, but it can be done if the employee’s plan allows for it.

Here’s how a loan from a 401(k) account works:

If the employee’s plan allows for loans, then the employee can borrow money from the 401(k) account, promising to repay it with interest within a time period determined by the plan administrator. The interest amount is a fixed rate that’s calculated by the plan administrator at the time the money is borrowed.

These loan payments are automatically deducted from an employee’s paycheck, just as contributions into the account would be. Unlike some loans such as mortgages, the interest paid on a loan from a 401(k) plan is NOT tax-deductible. It’s paid with after-tax money, meaning that loan payments are taken out of a worker’s paycheck AFTER all other taxes have been computed.

There’s one advantage to a getting a loan from a 401(k) account over taking an early withdrawal for a hardship case. As long as the loan is repaid on time, the amount of the loan won’t be subject to the penalty or the mandatory 20 percent withholding tax, as in an early withdrawal.

Other things to think about if you’re considering a loan from your 401(k) account:

• • Do the rules of your employer-sponsored plan allow for loans?
• • What if you leave employment before the loan is paid off? Will you be required to pay the remaining balance in full at your departure?
• • What are the consequences if you don’t repay the loan as the plan requires? In some cases, there are tax penalties involved.

The amount of a loan from a 401(k) depends on what the plan’s rules are. However, in general, if loans are allowed by the plan, the most money you can borrow is half of your total investment balance, or $50,000, whichever is less. Plus, if you’ve taken out previous loans within the past year, the amount available for borrowing will be reduced.

Finally, it’s essential to consider the long-term effects on your financial status of borrowing from your 401(k) account.

First, you’re borrowing from yourself; the loan money comes out of your retirement savings account. This means there won’t be as much money in your account, and so there is less money earning you interest. This is called losing earning potential.

Even if you repay the loan promptly and in full as required, you’ve still lost out on the earning potential of that money during the time it was not invested in the 401(k) account. What seems like a good strategy for the short term could prove to be a bad idea over the mid- or long term, especially if your investments show strong earnings during the time you’re repaying the loan.

Finally, even with a low interest rate on the loan, you’re the one paying the interest. In other words, instead of earning interest on the loan amount, you’re paying it. You’re not just repaying the amount that you borrowed, you’re paying for the privilege of having that money to use from your account, as well as the costs involved in keeping track of the money.

These realities make a loan from a 401(k) account “expensive money.”