Summer is here with plenty to look forward to – barbecues, the beach and baseball games, to name a few. It’s also a time when many families have extra expenses or are prepping for their financial responsibilities come autumn.
At Schwab Retirement Plan Services, Inc., we often see an increase in plan participants taking loans from their 401(k) account(s) during the summer months. Data shows that one of the reasons people borrow is to pay for vacations.* Another common reason is to cover tuition bills. But while taking a loan from a 401(k) account may seem like a quick solution, it’s rarely a good idea.
Typically, you should consider taking a loan from a 401(k) account as a last resort, for a number of reasons. For one, the repayment term is usually five years, and at the very least, you must make loan repayments quarterly. However, if you leave your job after taking the loan, you’ll need to pay it back quickly – in some cases, within as few as 60 days. If you can’t pay it in full, you’ll owe taxes on the balance and, if you’re under age 59½, you’ll likely owe an additional 10 percent tax penalty. These penalties and taxes can exacerbate what might already be a tough financial situation.
Another reason you may want to avoid dipping into your 401(k) account is that you could be cheating your future self by breaking your retirement savings habits. I’ve observed that some people stop saving in their 401(k) account while paying back a loan from the account – and some plans may not allow you to save in your plan until the loan is paid off. Not only can this get you off-track from your retirement savings goals, but also, the money you borrowed is no longer invested in your 401(k) account, so it misses out on any potential stock market growth. Remember, the savings in your 401(k) account should be for your retirement, and you don’t want to risk letting your present actions potentially hurt your financial future.
Here’s another thing to consider: even though it may seem like you’re borrowing from yourself when you take a loan from your 401(k) account, you still have to pay that loan back with interest. Not to mention, you have to pay it back with after-tax money, which then gets taxed again when you withdraw it at retirement. These after-tax loan repayments may reduce any pre-tax benefits of traditional 401(k) plans.
Finally, keep in mind that money in a 401(k) account is generally protected from creditors. It may be fair game once it’s out of the plan.
This summer and all year round, I’d encourage you to think twice before taking a loan from your 401(k) account. If you’re tempted to do so to help cover tuition costs, keep this in mind: while a student can take out a loan for college, you can’t take out a loan for retirement. Also, life’s little extras, like vacations, are important – but budgeting throughout the year may help you set those dollars aside without derailing your retirement savings goals. Happy saving, and happy summer!
* This online survey of U.S. 401(k) participants was conducted by Koski Research for Schwab Retirement Plan Services, Inc. (SRPS). Koski Research is neither affiliated with, nor employed by, SRPS. The survey is based on 1,000 interviews and has a three percent margin of error at the 95 percent confidence level. Survey respondents worked for companies with at least 25 employees, were current contributors to their 401(k) plans and were 25-70 years old. Survey respondents were not asked to indicate whether they had 401(k) accounts with SRPS. All data is self-reported by study participants and is not verified or validated. Respondents participated in the study between May 26 and June 3, 2015.
The information contained herein is proprietary to SRPS and is for general informational purposes only. None of the information constitutes a recommendation by SRPS. The information is not intended to provide tax, legal, or personalized advice. SRPS does not guarantee the suitability or potential value of any particular investment or information source. Certain information provided herein may be subject to change.
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