Borrowing from your retirement savings

by Gary Silverman, CFP®

I’m told the economy is doing just dandy, yet I can see the statistics that say people are saving less and racking up more and more debt. Life can throw you smack dab between a rock and a hard place. It’s times like this when you think about borrowing from your retirement savings, even though you know it’s not the best idea. While I hope you never find yourself in this situation, given the number of readers and the nature of life itself, I’m guessing someone reading this is struggling with this decision right now.

Not all workplace retirement savings plans are eligible for borrowing. If you’re with a small employer, they may have a SEP or SIMPLE IRA plan set up. You are not allowed to borrow from these plans. Larger firms and organizations, however, will often have a 401(k) or 403(b) plan. You might be able to borrow from these.

Might is the key word, because your employer’s plan must specifically allow a loan program. Not all do, so you’ll want to talk to your H.R. or Benefits department to find out. While you’re at it, ask how much you can borrow and what the repayment terms are. How long can you take to pay it back, and what will they charge in interest?

Yes, you’ll have to pay it back, with interest. The nice part: you will be paying the interest back into your own account, literally paying yourself instead of a credit card company or bank.  Even so, taking an advance from your retirement should not be taken lightly.

First, if you must resort to this, you’ve likely messed up your financial life in other areas. There’s a chance that the breakdown was not your fault. But other controllable factors could be at play. You may never have set up an emergency fund. You may be living above your income, letting your wants empty your wallet. You may not have been insured properly. A loan may get you out of the problem now, but if you keep the same habits, you won’t solve the underlying problem.

Then there’s the dent you put into your retirement savings. Yes, you’ll pay yourself back and then some, but while borrowed, the money is not in your plan growing. Thus, you’re “losing” the amount the account would have grown if the money was in there. (Unless the markets are down the entire time you are paying off the loan. In that case, you win. Though that’s not something you can really count on.)

One of the biggest problems with borrowing against a plan is not paying it back. After all, if you are already having trouble making ends meet before, an extra loan payment won’t help things too much. If you don’t make your payments, the loan becomes a distribution. That means you will be taxed and potentially penalized for borrowing from your future self.

There are a lot more details, caveats, and warnings when it comes to borrowing against your retirement plan at work. That doesn’t mean you shouldn’t do it. But be sure you consider all the angles and make the choice only if it’s the best course of action for you—and that includes avoiding the path you may have traveled to smack into that rock in the first place.