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SEPTEMBER 2012
Brought to you by Our Team
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RETIREMENT PLANNING
How to borrow from your
retirement savings
Raskin Planning Group
125 Summer Street, Suite 1400
Boston, MA 02110
617.728.7433
[email protected]
Peter Raskin
617.728.7433
[email protected]
Jessie Foster
617.728.7436
[email protected]
Justin Makso
617.728.7432
[email protected]
Rachel Mandeix
617.728.7464
[email protected]
A
401(k) loan can be a sensible alternative to other loan options for those who
need access to funds. But executing such a move requires careful planning
and an understanding of the long-term implications.
If you need extra cash for a project or to cover
a large expense, it may be tempting to use your
401(k) account as a financial lifeline. In fact, the
number of Americans borrowing from their
401(k)s is on the rise, growing from 18% of
plan participants in 2009 to 21% in 2010,
according to the most recent report from the
Employee Benefits Research Institute.1
“It’s definitely something people turn to in
times of unusual need or a tight lending environment such as current conditions,” says Julie
Stich, research director at the International
Foundation of Employee Benefit Plans. “But
while there are some advantages to borrowing
from your 401(k), the list of drawbacks is at
least as long.”
For many people, a 401(k) loan should be the
very last option, Stich says. Borrowing from
your 401(k) puts your future retirement plans
at risk, and you also face severe penalties if you
don’t pay the money back on time. You could
well have other options for raising cash—and
should investigate them before you tap your
retirement savings.
THE LOAN BASICS
Your employer dictates most of the rules for
borrowing from your 401(k), within the bounds
of regulations set by the IRS. Stich notes that
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while most employers do offer 401(k) loans,
they aren’t required to.
If your plan allows loans, there are certain rules
you need to follow. You can borrow up to the
lesser of either $50,000 or half your account
balance. You must repay the loan within five
years—but your employer can shorten the
repayment term.
And when you repay the loan, you’ll owe interest. For most 401(k) loans, the interest rate is
pegged to the prime rate plus another one or
two percentage points, Stich says. (The prime
rate was recently 3.25%,2 which would put the
average 401(k) loan rate at between 4.25% and
5.25%.) Stich notes that the reasonable rates
and the fact that you avoid the application
process of a commercial lender do make 401(k)
loans attractive. “It’s definitely cheaper than
running up credit card debt,” she says.
THE DRAWBACKS
But the potential disadvantages of borrowing
from your retirement plan abound. Researchers
estimate that more than 17% of 401(k) borrowers will fail to repay their loans this year.3 This
leads to stiff penalties: You’ll owe income tax
on the amount you haven’t repaid and a 10%
early withdrawal fee on that amount if you’re
younger than 59½.
SEPTEMBER 2012
EXPLORE THE ALTERNATIVES
About Our Practice
Life is full of financial
crossroads. Trying to navigate
these paths without an experienced
professional may lead to anxiety or
wrong decisions. The Raskin
Planning Group provides a unique
approach to financial advice that
combines experienced financial
knowledge with personalized
proactive service.
Stich says there are other concerns as well. If
you lose or change your job, your employer
can ask that you immediately repay the loan.
But the most worrisome consequences involve
the effect such a loan could have on your
overall retirement plan. Many borrowers aren’t
able to simultaneously repay their loans and
continue their regular contributions to their
401(k)s—causing their retirement savings to
fall further behind.
Then there’s the added drawback of depleting
your retirement funds. “The purpose of your
retirement plan is to save for retirement,” Stich
says. “If you’re taking money out, your balance
is lower for longer, and you miss out on all that
compounding interest.”
Before tapping into retirement savings, consider other ways to find or borrow the cash you
need. For instance, one alternative is a home
equity line of credit (HELOC). The interest
rates on HELOCs are often lower than those
on 401(k) loans, and the repayment schedules
are usually more flexible. What’s more, you
may be able to deduct the HELOC’s interest
payments on your income tax return.
Also consider meeting with your financial
planner to weigh other options, from selling
taxable investments to streamlining your
budget to free up more cash. If you do choose
to borrow from your 401(k), Stich advises that
you proceed with caution. “Do your homework,” she says. “It’s important for individuals
to understand what’s at stake.”
TALK TO YOUR FINANCIAL PLANNER ABOUT:
•Ways to plan for financial emergencies
•Alternatives to borrowing from your
retirement account
•How you can borrow from your
account without disrupting your overall
retirement plan
CRN201208-2071364
Employee Benefits Research Institute, “401(k) Plan Asset Allocation,
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Account Balances, and Loan Activity in 2010,” Dec. 2011, http://www
.ebri.org/publications/ib/index.cfm?fa=ibDisp&content_id=4968.
The Wall Street Journal, Market Data Center, http://online.wsj.com
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/mdc/public/page/2_3020-moneyrate.html.
Blake Ellis, “Loan Defaults Drain $37 Billion From 401(k)s Each
3
Year,” CNNMoney, 17 July 2012, http://money.cnn.com/2012/07/17
/retirement/401k-loan-defaults/index.htm.
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