We commonly see loans taken out against a client’s 401(k). “A recent report from TIAA-CREF found that nearly one-third of Americans have taken out a loan from their retirement plan savings.” In a pinch, tapping into a 401(k) account can be very attractive. While such a loan may be the best of not so great options, it is important to understand the drawbacks.
A 401(k) loan is easy because you do not have to qualify (just check with your plan administrator to see if allowed). As you are paying the loan back to yourself, the interest is credited to your account.
Yet this is still a debt. The “loaned” funds are not available to compound for your retirement. In addition, if you are terminated you must pay the entire amount back. If you do not have the money, you are liable for the IRS 10% penalty (if you are under 59½) in addition to the loan amount added to your taxable income. According to the pension research Council “86 percent of terminated workers with an outstanding loan balance default on their loans….”
Repayment of the loan can create a hardship making it harder to make your regular retirement contributions. Thus many end up saving less.
Think twice before you take out that 401(k) loan. Let us know if we can help with the decision concerning a 401(k) loan or if we can help set up a schedule for repayment.