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An illustration of a nest egg, with a dollar sign symbol, that's cracking.
An illustration of a nest egg, with a dollar sign symbol, that's cracking.
An illustration of a nest egg, with a dollar sign symbol, that's cracking.

Published April 18, 2019.

Tempted to borrow from your retirement? Resist.

Before borrowing from your retirement plan, consider the risks and costs.

A guy at work bought a new boat. Even better, he already had the money to pay for it ― right there in his 401(k). Borrowing the cash from his retirement account was easy, he told you, and he’ll be able to "pay himself back." No problem.

Tempted to follow suit? Resist, says Trey Lusk, a financial advisor at STCU Investment Services, provided by CFS.*

"A 401(k) loan is a tool you can use, but it gets abused too much," Lusk says. "Ultimately, a 401(k) should be used for retirement only."

Whether you can get a 401(k) loan depends on your plan. Some employers allow the loans only in cases of financial hardship. Others let you borrow money to buy a car, to improve your home, or for other purposes. And, regardless of why, the Internal Revenue Service will be watching to see whether penalties must be assessed.

In general, though, a 401(k) loan is relatively easy to get, with little paperwork, limited fees, and no credit check. And in most cases, the interest you pay on the cash you borrow is credited to your own plan account.

So this type of loan can serve as a viable, last-resort option for people facing financial emergencies. But Lusk advises anyone who needs cash to explore all other options first.

“If it's not in your best interest, we'll tell you," Lusk says. "If it is, we'll tell you that, too."

Borrowing from your 401(k) robs your future self of earnings on that cash if you'd left it in your retirement account. Considering the power of compound interest, those earnings could be significant.

A 401(k) loan also puts you at risk of hefty fees and tax bills if you leave your job — voluntarily or involuntarily — before repaying your loan, or you're unable to repay it on time (in general, within five years).

In either situation, if you're younger than 59½, your loan becomes a "taxable distribution" from your retirement account. And that subjects you to a 10% federal penalty tax, as well as regular income tax, on your outstanding loan balance.

One option if you're really strapped: Some 401(k) plans let you withdraw money, rather than borrow, if you're in "heavy and immediate" financial need. What that need looks like depends on your employer, but it might mean medical bills, funeral expenses, or imminent eviction.

Lusk says most people are better off looking at options like home equity lines of credit — in which you borrow against the equity you've built up in your home — or personal loans.

No matter what, talk to a financial advisor before touching your retirement plan, Lusk advises.

"Get a plan built for you, and figure it out," he says. "If it's not in your best interest, we'll tell you. If it is, we'll tell you that, too."


*Non-deposit investment products and services are offered through CUSO Financial Services, L.P. (CFS), a registered broker-dealer (member FINRA/SIPC) and SEC Registered Investment Advisor. Products offered through CFS are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment representatives are registered through CFS. This article is for informational purposes only and cannot be relied upon for the purpose of avoiding IRS penalties and is not intended to serve as tax, accounting, or legal advice. As with all matters of a tax or legal nature, you should consult your own tax or legal counsel for advice.

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