Pros and Cons of 401(k) Loans

The CARES Act has affected many Americans, especially retirement planners. Those with 401(k)s and other retirement saving accounts may be able to find financial relief in their retirement funds. These accounts are meant to fund retirement and come with strict rules to ensure its purpose. Typically, penalty-free withdrawals begin at age 59.5, meaning your money is locked in until then. However, you can withdraw some of the money in the form of a loan prior to that age but will incur penalties. Most 401(k)s are eligible for loans because you’re borrowing from your own money and paying interest to yourself. Under the new CARES Act, the government has not only increased the amount you can withdraw but has eliminated penalties. Sounds great, doesn’t it? I hate to break it to you, but it may not be your best choice. We’ve made a pros and cons list to help you make informed decisions.

PROS

No Loan Application

Because you’re essentially borrowing your own money, you won’t need to go through the rigorous loan application process. You will have to fill out some paperwork with the administrator, but you’ll skip lengthy credit checks, references, tax returns, etc. 

No Credit Score Minimum

Since this isn’t a traditional loan, your credit score won’t matter. Even low credit borrowers can get approved, depending on the account’s policy. This can make a huge difference for those with low credit scores or minimal assets.

Automatic Pay Back

Are you nervous about paying the loan back? Your auto-contributions will go towards the loan and interest until it’s paid off. Once the loan and interest are paid off, your auto-contributions will go back to being added to the balance of the account.

Interest Goes in Your Pocket

The interest you’re paying ends up in your pocket, meaning you’ll avoid losing money on high-interest loans.

CONS

Lost Growth

Pulling investments can result in lost growth. Despite only taking a portion of the balance, you may lose gains because the money will be gone for at least a short period. You may also lose earnings on your  contributions that now go toward paying back the loan.

Penalties

Your administrator can penalize you for several things. Of course, if you don’t pay the loan back you’ll be hit with fees and the loan may even be considered as a withdrawal, which is hit with more fees and taxes. If you leave your job, voluntarily or not, the repayment will be accelerated to the nearest tax return due date, though you may file for an extension.

Jeopardize Retirement

Borrowing from your 401(k) will most likely affect your retirement savings. Though it is possible to bounce back, depending on the loan size it may take longer than you’d expect. Experts say retirees need at least $1,000,000 saved for retirement, and the number grows with inflation and lifestyle changes.

What now?

You have the facts to help you decide, but sometimes that still isn’t enough. Consider the purpose of the loan and the necessity to get it. There may be money hiding in places you didn’t even know. Perhaps there’s a more efficient loan tool.

Your best bet to informed decision making is finding a financial consultant. This person can present scenario projections, retirement savings vehicles, and more. Whether you’re certain you’ll take a loan or just thinking about it, let’s chat about your next move. Schedule a time to virtually discuss your situation and goals so we can help you achieve your best retirement! To kickstart a free virtual retirement savings conversation, click the link below, call 1-800-467-8152, or email info@ronaldgelok.com.

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