Borrowing from 401(k) can cost more than you think

More investors are taking out loans against their 401(k)s, and that could hurt their retirement income by hundreds of dollars a month, according to an analysis by Fidelity Investments released Wednesday.

The number of investors borrowing from their 401(k)s has been steadily increasing for more than a decade. Today, more than one in five people, or 22.5% of Fidelity's 401(k) investors, borrow against their retirement savings, up from 18.7% in 2000, according to Fidelity's analysis of 13 million investors.

More than 2 million investors have outstanding loans, and nearly 1 million took out loans in the past year.

What's most concerning, says Jeanne Thompson, vice president of thought leadership for Fidelity, is that the analysis finds that a significant portion of those who borrow aren't able to maintain their previous savings rate: 40% of borrowers reduce their savings rate, and of those, more than a third stop contributing to their 401(k) altogether within five years of taking a loan.

Half of borrowers go on to take out another loan. Fidelity calls them "serial borrowers."

"They're almost treating their 401(k) like a checking account," Thompson says. "If you're never paying a loan off in full, you're constantly playing catch-up."

Fidelity finds you're also going to be way behind when it comes to how much you have to live off of during retirement. In a hypothetical analysis, Fidelity found that investors saving at a rate of 10% who fall to a rate of 5% for five years will receive nearly $200 less each month in retirement. Those who stop saving completely over 10 years will have nearly $700 less a month in retirement.

Currently, 401(k) investors are contributing an average of 8% of their incomes.

"I don't think that's something people think about when they take out the loan," Thompson says. "Think about what you could do with $690 a month in retirement."

While Thompson says more borrowers are taking out general loans, likely in emergencies, a small portion are taking out large home loans. Millennials are borrowing the most for homes, at an average of $17,100, or 37% of their retirement savings. But just 3.6% of Millennial investors do so.

They may also be in the most trouble when it comes to paying the loans back. Known for only staying at companies a few years, Gen Y could be hurting their retirement savings even more when they leave a company, which is when 401(k) loans have to be paid off. Those who can't pay off their loans in full still have to pay all taxes owed on the balance and a 10% penalty if they're younger than 59.5, Thompson says.

She recommends taking out a 401(k) loan only if you know you can maintain your savings rate and will be at your job long enough to be able to pay the loan back. And given the number of serial borrowers, an emergency savings fund is crucial, she says.

"Serial borrowers are the ones that are taking (loans) for the smallest amounts," Thompson says, adding that even saving $10 a week will add up for borrowers typically taking out loans for $500 to $1,000. "Some people think $10 won't make a difference. But it will over time. To some extent it's a bit like dieting."