Should You Borrow from Your 401k?
As of March 2024, the average household carrying revolving credit card debt holds a balance of $21,083, with interest rates at a steep 27.65%. This has left many individuals questioning, “Should I borrow from my 401(k) to pay off debt or make a significant purchase?”1,2
While tapping into your retirement savings may seem like a quick solution, it’s important to weigh the benefits and risks before making a decision.
Borrowing from Your 401(k): The Advantages
No Credit Check: One of the perks of borrowing from a 401(k) is that it doesn’t require a credit check. As long as your plan allows for loans, you can typically access your funds without the hurdles of traditional lending.
Convenience: The process is generally quicker and requires less paperwork than applying for a personal loan. You may find it easier to get your hands on the funds when time is of the essence.
Lower Interest Rates: The interest rate on a 401(k) loan is usually lower than credit card or personal loan rates. What’s more, the interest you pay goes back into your own account, not to a lender.
The Drawbacks of 401(k) Loans
Lost Growth Potential: While your money is loaned out, it isn’t earning the potential returns your investments could be generating. Moreover, many borrowers stop contributing to their 401(k) while repaying the loan, which compounds the impact by reducing future growth and any employer-matching contributions.
Job Loss Concerns: If you leave or lose your job while repaying a 401(k) loan, you could be required to repay the loan within a short time frame (often five years). If not, the outstanding balance may be considered a distribution, making it subject to income tax and, if you're under 59½, a 10% penalty.3
Overspending Alert: Using retirement funds to cover current expenses might indicate deeper financial issues, like overspending. While paying off high-interest debt may seem like a smart move, if you end up running up credit card balances again, you could worsen your financial situation.
Is It the Right Choice?
Most financial experts caution against borrowing from your 401(k) unless absolutely necessary. The long-term impact on your retirement savings can be significant. However, if you find yourself in a financial emergency, it may be a better alternative to withdrawing funds outright and facing steep penalties.
Remember, if you decide to borrow, make sure it’s part of a larger financial strategy to address your spending habits and ensure that once the debt is repaid, you don’t fall into the same trap. Our advisors here at Deschutes are available to answer any questions you may have on this topic. Contact Us Here to schedule a consultation.
Sources
- NerdWallet.com, January 8, 2024
- Forbes.com, May 20, 2024
- IRS.gov, 2024