The Truth about Borrowing from Retirement Plans

by on November 22, 2017

Most people have entered a retirement plan to save some cash for the future. When you have a 401 (k) account, your contributions to your retirement plan are automatically deducted from your bank account when your monthly salary is remitted. On the bright side, your employer is legally bound to match your contributions to help build your savings. That means the more your deductions; the more your employer contributes towards your retirement plan.

However, although you’re allowed to borrow from your retirement account, there are restrictions on it. One of these standard measures is that you can’t borrow an amount equal to what’s in your account. You can only borrow up to half your savings.

What Makes People Do It?

As is a fact, no one would really want to mark their retirement savings as the go-to account when they encounter the slightest financial problem. So, what makes people break their own retirement savings account? What would make you withdraw your retirement money before it’s due?

• When you’ve reached the end of the rope: Sometimes, you might not be getting an emergency loan from other lending institutions. This would make you run out of options, leaving your retirement savings to account as a last resort. In this case, you might have to make an early withdrawal from the account.

• When you can’t get a loan at a better rate: Let’s say you’ve explored various other loan options, but failed to find one with the lowest and most affordable interest rate. This could happen, especially when your credit score is too low to qualify for a loan or it can only qualify for a loan with a high-interest rate. At this point, you might opt to borrow from your 401(k) account if it extends a lower rate.

• When you need the money for a smart investment: If you come up with a smart investment plan like an increasing investment in a business, buying a home, or covering your kids’ education before you reach your retirement age, you may choose to withdraw the money when it accumulates to the desired amount.

The Pros

As is often the case, withdrawals from retirement accounts come at a better rate than most other lending options, and that potential advantage to save more on the cost of a loan could encourage people to choose this option over others.

Also, if you happen to find yourself in an extreme financial pit and you can’t find another viable option, borrowing from your retirement plan could help breathe life back into your economic health, most especially if it’s all you’ve got.

Take an instance where you entered into a retirement plan with the aim of saving enough money to start a project – say buying a home or starting a business. You can contribute to your account and then make a withdrawal the moment your account has accumulated the needed amount. However, keep in mind that this “needed amount” would be a fraction of the total savings in your account – so be sure to do the math appropriately.

The Cons

While making a much-needed withdrawal from your retirement plan can save you from a financial crisis, you don’t make to go scot-free. You see, your retirement plan is supposed to legally mature when you hit your retirement age, and that means “messing” it up before the due date has some repercussions to deal with.

• First of all, this option is pretty risky. A retirement plan is your last line of defense against unforeseen future expenses that may come up after you’ve retired. Borrowing from this account early takes your retirement money out of the equation, and that defeats the general purpose of the retirement plan.

• If you lose or leave your job before you clear the borrowed amount, the terms change and then you’re required to pay back almost immediately – typically within 60 days. If you fail to pay back, the remaining amount in your account is disbursed and considered payment for your retirement. Since it’s also treated as payment for an early retirement, this money is subject to penalties slapped on it on the basis that you’ve breached the general agreement of accessing your money after retirement. Also, the money is further subject to income tax deductions as it is considered direct payment.

• Borrowing from your retirement plan could see you paying tax twice. First, you realize that you pay tax when your salaries are remitted by your employer before an amount is deducted and transferred to your 401(k) account. Secondly, an early withdrawal from that same account would be treated as a payment or loan, and that’s subject to tax deductions and other legal charges. In essence, you pay tax on the same money multiple times when you take it off your retirement savings.

The Final Take

Sometimes, borrowing money from your retirement plan can help end an untimely financial crisis, but it comes at a cost. To this end, you should take this route only as a last resort or where the benefits largely outweigh the costs. To make this a reality, you need to have an easily accessible account with enough emergency funds to cover some immediate expenses that may come up anytime. This would go a long way in preventing a serious financial fix that may force you to access your retirement savings before its maturity.

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