To borrow or not to borrow … from your 401(k)

Keep these points in mind:

  • All CARE changes apply only if your plan allows loans
  • Loan limit is increased from $50,000 to $100.000 temporarily (if your employer plan allows it)
  • Rather than 50% of your account balance, CARE allows borrowing 100% of vested balance
  • Loan payments due to December 31 can be deferred for one year
  • Interest will accrue even during the period you may defer loan payments

Unless it is absolutely financially necessary to meet everyday living expenses, do not borrow, because:

  • You are locking in losses taking out money when the market is down
  • Since you have the cash out of your plan account, you will not participate in any growth in investment value during the period of your loan
  • The interest you pay on your loan will eventually become taxable income to you
  • Eventually you will have to make loan payments which may limit your ability to make your own contributions and perhaps forfeit employer matching contributions.

4 comments

  1. Wrong.
    You state:
    “… Unless it is absolutely financially necessary to meet everyday living expenses, do not borrow, because, you are locking in losses taking out money when the market is down, … you will not participate in any growth in investment value during the period of your loan, … the interest you pay on your loan will eventually become taxable income to you, … eventually you will have to make loan payments which may limit your ability to make your own contributions and perhaps forfeit employer matching contributions.”

    Consider:
    It is better to borrow than to take a distribution, which CARES also allows for the exact same individuals,
    It is better to borrow from the plan, at prime interest rates, than to borrow from a commercial source at higher interest rates,
    A borrower need not “lock in losses”, when borrowing, the loan principal becomes a fixed income investment in you, so, if you reallocate your 401(k) account to the targeted asset allocation, by treating the plan loan principal as the fixed income investment it is, your equity exposure will be unchanged and you can participate in any market rebound.
    Yes, interest you pay on the loan will be taxed the same as interest on any other fixed income investment – compared to say the interest you pay on a commercial loan that you won’t receive back from the bank,
    Yes, you have to pay the loan back, to rebuild the account, for a future, larger use – however, if you think paying the loan back at prime interest rates will be a burden, inhibiting your ability to contribute to the plan, what would loan payments to a commercial bank, at much higher interest rates, do to your ability to make contributions?
    Finally, if the interest rate on the plan loan is less than the interest rate on a loan from a commercial source (almost always true) and if the interest rate on the plan loan is greater than the rate of return on fixed income investments in your plan (true for the past decade or so), you will actually improve both your household balance sheet AND your retirement preparation – compared to borrowing from a commercial source.

    No, don’t borrow unless you need money. Then, be savvy about your financial decision. Many times, a plan loan may be a person’s only available source of credit, or it may clearly be the better choice when compared to available alternatives (commercial loans, withdrawals, etc.)

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      1. I agree. They should have been more careful when they decided to allow participants to “self-attest” that they were qualified for a COVID-19 related distribution of 100% of their account balance up to $100,000. This could become the “liar loan” of 2020. Some will need the cash – whether or not affected by COVID-19. Some will take the money just in case. Some will take the money because they can tax average the payout over three years (avoid a higher marginal income tax rate). And, can’t wait to see how they handle situations/administer the “repayment” where a portion of the money was 401(k) contributions, a portion was employer contributions, a portion was an IRA rollover into the plan, and a portion was Roth 401(k) contributions. .

        It is an election year, isn’t it? No surprise in how our government has responded – by votes today, let future governments and future generations of taxpayers struggle with the net effect of our decisions. .
        See: https://www.wsj.com/articles/upgrade-our-8-track-government-11587317309?mod=searchresults&page=1&pos=1

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    1. Back in the mid-1990, I borrowed $13K from my 401K. I didn’t want to do it but it was my only source that I could borrow from. The purpose was to buy the adjacent lot next to my house in a city. I did have to reduce my contributions some and I paid it off early. It turned out that I actually had positive earnings because I was paying back myself with interest compared to my peer’s funds who were losing money. It was a fluke. When I sold that house, the house was more valuable because of the double lot so I made it up in the long term too.

      Given a choice, I would take a loan from 401K if I needed to eat or keep the roof over my head. Paying myself back would be preferred than a bank, if they will even give you a loan with no job. I also don’t think there will be a sharp return in the markets so I believe if you keep the term short you can still buy back into the market a low rates.

      I would never use a 401k loan to take a vacation or buy a boat.

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