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Emergencies that require an urgent boost in cash flow can pop up at any time. Perhaps your car breaks down or maybe you need a new HVAC system. When scenarios such as these enter into our lives, it can be tempting to reach into our retirement accounts as a way of solving the problem.
Unfortunately, this is almost always a mistake, and one that countless individuals have made unwittingly at some point in their lives.
Here are just a few of the reasons why you should think twice about borrowing from your retirement plans.
1. Borrowing Disrupts Your Savings Plan
Retirement plans are named as such for a reason—they’re quite literally mapped out to provide a secure financial future. Some 401(k) plans allow for wiggle room, but in most cases, these plans are meant to be stuck to for the duration of their existence. When you borrow from a 401(k), you typically won’t be allowed to make additional contributions to your plan until the loan is paid off in full. Essentially, borrowing defeats the purpose of having the plan in place, which is reason enough to put the idea to bed.
2. You’ll Lose Out on Tax Benefits
Taxation and retirement plans go hand-in-hand. The major factor that causes people to embrace an employer’s 401(k) plan is that contributions are pre-tax, which can mean a significant financial benefit during a long enough span of time. Take out a loan, and you’ll end up paying on it with after-tax money, which—again—negates any of the tax benefits associated with holding money in a 401(k) in the first place.
3. You Might Risk Your Future Security
The vast majority of people who take out loans from their retirement plans do so because they find themselves in dire financial straits. But what happens when you can’t repay the loan you took out? In this scenario, the loan is essentially treated as a withdrawal, which means the balance will not only be subject to income taxes, but an additional 10 percent early withdrawal penalty for those under the age of 59½. When you’re saving for the future and nearing retirement age, a withdrawal penalty can be a huge setback.
4. You must Repay the Loan Immediately Upon Termination
If you’re still working, you’re still actively building a retirement savings. Perhaps you’ve built up a sizeable nest egg and are considering taking out a loan before you reach retirement age. In the chance that you’re terminated in the meantime, you’ll most likely have to pay the balance of the loan in full, immediately. It doesn’t matter if you’ve been fired, laid-off, or quit on your own volition—you’ll likely find yourself responsible for a large sum of money, not to mention taxes and withdrawal penalties.
As you can see, borrowing from a 401(k) or other type of retirement plan won’t do you any real favors in the long run. If you’re on the fence, be sure to discuss your situation with an expert financial advisor before making any quick decisions—your retirement depends upon it.