When employee benefit plan participants find themselves in tough financial positions, they often look for ways to relieve their financial burden. One of the options is taking out a loan from your 401(k) plan. However, is this a good idea? The answer – it depends on the situation.
For most people, the idea of taking out a 401(k) loan is like committing robbery on your retirement account and highly frowned upon. However, there have been studies that estimate nearly 20% of participants have loans outstanding on their retirement account. Clearly, this is a more common event than expected. For those in serious near-term liquidity situations who have very limited options, taking a loan from your retirement account might be one of the more cost-effective methods. This can be a participant who is not able to take out a personal loan from a bank and/or must rely on payday or pawn loans with extremely high interest rates.
Let’s look at a few situations where it may be cost advantageous to dip into your retirement account:
- Getting these types of loans are quick and easy. There is no inquiry on your credit and usually can be taken from your 401(k) plan’s website.
- Paying it back can be easy. For most plans, repayments are made through payroll deductions and are normally paid back in five years.
- There are low upfront costs when compared to other loan types. Depending on the plan, there might be a small origination fee.
- Interest rates are generally low and comparable to banks and significantly lower than payday and/or pawn loans.
- You might lose less money during down markets. Interest rates paid on a loan might be less than the market value decrease during a recession.
In conclusion, don’t let the negative views on taking a loan on your retirement balance take that option away from you. When you are in a financial pinch, taking a loan from your retirement account might not be the worst option and could be your most cost-effective solution.
Patrick Herrera, CPA