Why do people have to pay back money they take out from their retirement, it’s their money right?
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The person is setting aside their money into a special spot for a specific purpose. Because the person is putting their money aside for this special purpose of retirement, the government has not required the person to pay taxes on that income like everyone else is required to pay.
The government is making a deal with the person. Ok, if you set some of your own money aside for retirement we consider that such a good thing for us as a country (the government will be less likely to have to pay for you when you stop working) that we will not take out our regular portion in taxes. The money is set aside pretax. Before taxes are taken out.
If you break the deal taking out the money, which is something you have the ability to do, you will have to pay the taxes on your money because it is no longer being used for the special purpose of retirement and you get a bit of a slap on the wrist for breaking the deal by have to pay a 10% penalty.
When you get a loan from your special purpose money, you are essentially borrowing your own money with no third-party lender involved. No credit check is needed and all the your loan payments, including interest, go right back into your 401(k) account and it does not effect your credit score.
As long as you pay it back in time, you avoid paying the taxes on the money you borrowed from yourself and the interest rate is lower than just going out and getting a regular loan.
Being able to borrow from your special purpose money if something comes up and you need it encourages people to set more money aside.
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