Should you take a loan out of your 401k?

During times of high financial stress, the idea of taking a loan out of your retirement savings fund can sound like the perfect solution. After all, it’s your money, right?

Who wouldn’t consider taking advantage of money that you already have set aside for the future, isn’t that what it’s for?

It’s clearly the quickest option. Sometimes it offers a better, lower-interest rate than other loan options you’re looking at. It doesn’t require a credit check, and you can always pay the loan back during the designated repayment period to avoid any tax penalties.

On the surface, it sounds like the perfect option for when you find yourself in a pinch. But as with anything that sounds too good to be true, there’s always a catch.

Such is life, right?

We’ve decided to break it down by first focusing on why you’re considering taking out the loan to begin with, and helping you better determine whether sacrificing your retirement fund is truly the best option here.

Common reasons you might be considering it:

  • Putting a down payment on a house
  • Paying off a high interest credit card
  • You have another smart investment option lined up
  • Paying off an unexpected medical bill
  • Furthering your education
  • Avoiding bankruptcy
  • Paying back tax money owed to the IRS

While these are all valid enough reasons, the hard truth is that “nearly one-third of baby boomers had no money saved in retirement plans as of 2014, when they were on average 58 years old”.

For those that think this might be just be a “generational thing”, they’ll be surprised to hear that “95% of millennials aren’t saving enough for retirement, as well.

Meaning that, by taking what you think is actually the least harmful and financially smart route now, your future self might be the one paying for the cost of your missed retirement savings.

So, now what? As with any other question concerning your retirement plan, every individual and their financial situation is unique and should be treated as so. But more often than not, we would advise looking at all other options before deciding to take a loan out of your 401k, and here’s why:

  • There are plenty of other loan options available. If your credit is good, you can also typically get approved for a much higher loan amount. Contrary to popular belief, you might even be able to find a lower-interest rate with other personal loan providers, than you would through your own 401k.
  • When taking a loan out of your 401k, you are basically making the assumption that your job is secure. Now what if you found a better job or your current work environment was no longer suitable. You’d be required to pay back any unvested funds to that employer, before the next tax year.
  • The repayment terms on a 401k loan are typically a lot more restrictive than if you were to take a private loan out. Meaning that if you default on a payment, you’re setting yourself up for even more debt than you started out with.
  • In some cases, you will be losing money. Certain 401k plans do not allow you or your employer to make contributions to your account, while its in repayment status. So now, not only has your retirement fund taken a massive hit, you are also hindering any future savings until it’s been paid off.
  • You would basically be paying interest to yourself. Interest is never a good thing, so why would you want money out of your own paycheck going towards interest, versus your current living expenses.

We recognize and understand that planning for the future can be stressful. With all of the information out there it can be tempting to take the easiest, and quickest solution when you’re in a financial bind.

Given all the factors that come into play when deciding what type of loan is best for you financially, we understand that there aren’t always better alternatives.

However, we wouldn’t be able to call ourselves retirement planning experts if we didn’t ask you to at least review all other options, before deciding to take out a loan on your 401k. If it turns out that this is the best possible option, then we’re here to help you navigate a successful plan moving forward. Part of which, should always include an emergency savings fund to avoid having to make a decision like this in the future.