One of the key advantages of participating in your employer's 401(k) plan is that you may be able to borrow money from the plan if you need to for any reason. And borrowing may seem like "free money" because you pay the interest back to your own account, perhaps at a lower rate than you would pay on other types of loans.

The true cost of a 401(k) loan, however, can be steep. One reason is the tax bill. The advantage of tax-deferred contributions is not available for loan repayments. Thus, when it comes time to pay back the money you borrowed from your plan, you will have to use after-tax dollars.

Another disadvantage is the opportunity cost. Even though you are paying yourself interest, no added return is earned. Your money ends up being shifted around, but not one new penny is added to your overall assets. You give up all the real earnings the borrowed money would have earned had it stayed in your plan account, and you run the risk of not being fully invested in the investment markets when the best growth opportunities occur.

These circumstances could result in substantial lost earnings and reduce the eventual size of your plan account.

If something interferes with your repayment schedule (for example, a change of employer), your loan could become a cash problem. If you switch employers, you would have two options: repay the entire balance or consider the outstanding balance an early plan withdrawal. If sufficient funds were available, you probably wouldn't have needed the loan in the first place. So, repayment probably wouldn't be practical. But, if you treat the balance due as an early withdrawal, you will usually have to pay a 10% penalty in addition to regular income taxes.

The length of the repayment period for a 401(k) loan could also be problematic. By law, the term of a 401(k) loan is limited to five years -- unless its purpose is funding the purchase of a principal residence. That rule could cause timing problems if you were planning on using your loan proceeds for college expenses.

Repayment of a loan for freshman year expenses would have to be completed just a year after graduation.

Bottom line: Save your 401(k) assets for retirement. Research other loans which offer a longer term, such as a home equity loan, and which may prove a more comfortable way to cover major spending needs.

Emily S Hazlett is Vice-President:Investments at ENB Insurance Agency, Inc. a wholly owned subsidiary of Evans National Bank.