Should I take a loan from my retirement plan?
Borrowing from your savings is one way to access funds, but there are plan contribution and tax implications to be aware of.
Consider the pros and cons
It’s possible your employer has offered the option of borrowing from your workplace retirement plan savings. While your account is designed to act more like a nest egg than a piggy bank, it’s nice to have the flexibility to access funds if you have to before retirement.
You’ll want to keep in mind, however, the effects a loan may have on your future contributions, investment earnings, and taxes. Once you’ve considered the ins and outs of how a retirement plan loan works, you’ll be able to make a good decision when you’re tempted to grab the cash.
How does a retirement plan loan work?
First, understand that plans differ on how loans are administered, and all plans must follow certain federal rules. You’ll want to check with your employer to understand loan rules specific to your plan.
When you take a plan loan, you borrow from the amount you’ve already saved. You’re not borrowing from an employer or a lender.
So let’s say you have $40,000 in your account, and you’ve determined that you need $10,000 in cash. You can take a $10,000 loan from your own savings, leaving you with $30,000 in your plan. You receive a check for $10,000 that you can use as you please.1
How much can I borrow?
The loan amount available to you will be determined by both individual plan and federal rules. Generally, the maximum amount available is either $50,000 or one-half of your vested plan balance, whichever is less.
How do I pay my loan back?
When you take a loan, you also commit to pay it back. You’ll agree to a term and a monthly payment amount, including interest, to be deducted from your paycheck. The amount deducted is after-tax, so those particular contributions will no longer be part of your tax-deferred benefit.
What are the downsides to taking a loan?
You should know there are several reasons not to take a loan from your retirement plan unless you absolutely have to.
- If you leave your employer, you may be required to repay your loan in full within 60 days. For large, outstanding loan amounts, this might be difficult. If you can’t pay it back, it may be considered a distribution. In that case, you’ll be subject to paying taxes on your outstanding loan balance, as well as a 10% penalty if you’re younger than 59 ½.
- The interest you pay will actually be taxed twice: once when it comes out of your paycheck, and again in retirement when it’s taxed the same as your pre-tax contributions.
- It can be hard to continue making plan contributions when you’re already deducting your pay to repay the loan. Suspending plan contributions could cause you to miss out on free money if your employer offers a match. On top of that, you’ll disrupt the potential benefit of dollar-cost averaging, an investing technique generally considered to be wise in retirement plans. Both of these factors could delay your retirement goals.
Is there a good reason to take a loan?
Borrowing from your plan doesn’t require a credit check, and you’re not paying interest to someone else. Also, interest rates on retirement plan loans are relatively low and typically less burdensome than other types of credit.
The process of taking a loan from your retirement plan is simple, and it doesn’t take long to get your check. Because of this, it’s one of the easier ways to access cash. If you have a financial goal that requires cash, like paying down bad debt or starting a business, borrowing from your plan can be a reasonable option. Just remember that the loan should typically be a last resort.
The bottom line
If you’re thinking about a retirement plan loan, remember the associated risks and tax implications. A retirement plan loan should be your last resort for accessing cash, and you should consider looking into other borrowing options. BB&T offers home, personal, and auto loans, as well as lines of credit that could better meet your immediate needs and help keep your nest egg intact.