As you watch your retirement plan grow, you might be tempted to maybe borrow a little money from it here and there via retirement plan loans. After all, there’s always something (a wedding, a new kitchen remodel, a family emergency) that needs funded, right?
However, retirement plan loans are almost never a good idea – even in dire circumstances. Even taking a small amount out of a retirement plan like a 401(k) can cost you more in the long run. And for young adults – in their 20s, 30s and 40s – it can be even worse.
Why? It’s something called retirement readiness, and it basically means the younger you are, the more time you need to save.
The fact is, retirement plan loans are not uncommon. According to 401k.org, about 90% of plans allow for loans, with roughly 23% of people who are eligible to take loans taking them. The average loan amount is about $8,700.
Of course, not every retirement plan allows you to take a loan out, but most do. However, looking at your 401(k) as a source of credit or cash for emergencies shouldn’t be something you consider.
You might also have to pay taxes on the loan, which could cost you even more. Another reason against taking out retirement plan loans? You might be missing out on investment gains on the amount borrowed.
So, what can you do to prepare for life’s unexpected financial hardships? Create a viable and healthy emergency fund by saving each month for the inevitable.
Can there be advantages? Certainly. There is usually no credit check required and you might not have to pay taxes or penalties unless you default on your loan. You can also get a loan quickly and for almost any reason.
However, the disadvantages to retirement plan loans are not minor. You will fall behind on potential investment gains and paying back your loan with after-tax dollars. Typically, contributions to a 401 (K) plan are pre-tax. And if you leave your job or get fired, you’ll have to repay the loan – and fast. Usually within 60 days.
It pays to speak to a trusted financial advisor or planner before taking out a retirement plan loan, to ensure you are making the best possible decision.
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If you have other questions about retirement plan loans, email us or call 937.308.0758.
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