You’ve got a home improvement project slated for next spring, and you don’t plan on retiring for quite some time. What’s the harm in taking a small loan from your 401(k)? The money is just sitting there…and technically it is your money…right?
Many people have considered borrowing from their 401(k) savings to fund an immediate project, or for other needs. While there are benefits in doing so, there are also disadvantages to consider. The important thing to remember is that borrowing money from your 401(k) account is much different than dipping into your savings.
For many, borrowing money from your retirement account may seem almost taboo. Many of us started these accounts years ago with the intention of never touching the money until retirement; it is deeply ingrained in us.
When borrowing money from a 401(k) account, the process is typically relatively easy compared to borrowing from other lenders. Normally, there are no credit checks or lengthy applications1. Many requests for 401(k) loans can be made with a few clicks on a website, and you may be able to have a check in your hand within a few days. This is a good option for those who do not have great credit scores, or who cannot afford to have a loan request impact their credit rating.
Unfortunately, borrowing money from your own retirement also has downsides. Much like traditional loans, the loan from your 401(k) account has to be repaid, but not on your schedule. Typically, the amount borrowed must be repaid within five years, and if you leave your job, it must be re-paid within 60 days. If you are unable to pay the loan back in this timeframe, the amount you borrowed will likely be considered a distribution and subject to income tax. For those under age 59½, an early withdrawal penalty may applysup>2. Also, these repayments are not pretax, something you had enjoyed when you first funded the 401(k) account.
Yet another downside of borrowing from your 401(k) is the fact that you are taking your money out of the markets. Given that it’s no longer invested, you would be forfeiting the opportunity to benefit from compounding, and potentially significant tax-deferred growthsup>3.
Lastly, another disadvantage to consider is that it may be difficult to re-pay the loan and still save for retirement. If one were to take the full five years to repay the loan, and was not able to make any retirement plan contributions over this time period, it could negatively impact the amount that the individual is able to accumulate for his or her later years.
Depending on your needs, goals, and your other sources of available funds, borrowing money from your 401(k) account might be an option to obtain cash quickly. However, like most loans, there are pros and cons associated with this type of loan and you should carefully consider the disadvantages of this option. Speak to your financial advisor to learn if borrowing from your 401(k) plan is a viable strategy for you.
Apella Capital, LLC does not provide tax or legal advice and nothing either stated or implied here should be inferred as providing such advice. The information is provided for educational purposes only.
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