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Risks of Borrowing Money from Your 401(k)

Posted by Brad Bridgewater on Feb 29, 2016 3:05:02 PM
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risk_v_reward_-_blog.jpgCan
 you borrow money from your 401(k) plan? Yes. Should you? For most 401(k) participants, very rarely. While you may have a need to borrow from your 401(k) savings, it’s important to understand that doing so may have serious consequences.

You will be taxed twice

The money you contribute to your 401(k) is not taxed because it's deducted from your taxable income. In contrast, the money you use to pay back the loan has already been taxed, so you miss out on the difference. You then pay taxes on it again in the future, when you take a distribution from your 401(k) or IRA.

Your Contributions Will Likely Suffer

Many 401(k) plans do not allow you to make contributions if you have an outstanding loan. Even if your loan does not have that provision, if you took out a loan and are now in a position where you have to pay it back with interest, you most likely don’t have the money to fully fund your retirement plan to the maximum allowed by the IRS. Depending on how long you are paying the loan back, this could do considerable damage to your retirement plan.

Time is Working Against You

The entire premise behind long-term retirement planning is that time and the markets usually work together in your favor. When you take out a loan, you push "pause" on that long-term plan, preventing time from working its investing magic in the form of compound interest.

It's a Gamble

The market is in constant flux and the premise of long-term retirement planning is that several decades-worth of savings will weather the storm. If the market is up—or goes up—while borrowed money is missing from the pot, you miss out on greater earnings and will suffer more dramatically in future downturns.

Although these aspects are important to consider, because of the termination of the traditional pension plans, pilots typically receive large company contributions in their 401(k) plan each year up until retirement, which is further enhanced by the ability to fly until age 65. For airline pilots, taking a loan from a 401(k) plan poses less of a threat to retirement due to the loan amounts available relative to the size of their potential current or future 401(k) savings. Having said that, the cost of doing so should make anyone pause and look for other alternatives to meet their needs.

Ask a Professional

It's always best to consult with a professional financial advisor before withdrawing funds from a retirement plan. If you have questions about how borrowing from a 401(k) plan could affect your financial situation, request a free financial consultation with Retirement Advisors of America. We'd be happy to discuss this with you.

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Disclaimer: This blog is intended for informational purposes only and should not be construed as individual investment advice. Actual recommendations are provided by Retirement Advisors of America following consultation and are custom-tailored to each investor’s unique needs and circumstances. The information contained herein is from sources believed to be accurate and reliable. However, Retirement Advisors of America accepts no legal responsibility for any errors or omissions. Investments in stocks, bonds, and mutual funds may increase or decrease in value. Past performance is no guarantee of future results. Any of the charts and graphs included in this blog are not recommendations for the purchase and sale of any security. 

Topics: Financial Planning