Borrowing from Your Retirement Savings

By Gary Silverman, CFP®

Any COVID stimulus money you may have received is likely spent. Inflation is up, and with it, the cost of living is going up faster than your paycheck. And holiday spending probably didn’t help your budget. You may be thinking 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. These plans are more likely to be eligible for borrowing.

An employer plan must specifically allow a loan program. Talk with your H.R. or Benefits department to find out if yours does. And while you’re talking with them, ask how much you can borrow, what the repayment terms are, and what they will charge in interest?

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

First, if you must resort to this, other parts of your financial life may need a little TLC. You likely don’t have an emergency fund, or if you do, it isn’t big enough. You may be living above your income, letting your wants empty your wallet. You may not have been insured properly. A loan may solve the problem now, but if you keep the same habits, the underlying problem will wreak havoc again.

Then there is the dent you put into your retirement savings. Yes, you will pay yourself back and then some. But while borrowed, the money is not in your plan growing. Thus, you are “losing” the amount the account would have grown if the money was invested that entire time (opportunity cost).

One of the biggest problems with borrowing against a plan is if you don’t pay it back. After all, if you are already having trouble making ends meet, an extra loan payment won’t help things. 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. On top of that, if you leave the job before it’s paid back, the entire amount owed usually needs to be paid in full or the same tax and penalties may apply.

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 angles and make the choice only if it is the best course of action for you—and that includes avoiding the path that led you to borrowing from the plan in the first place.