I recently came across an interesting article in USA Today about borrowing money from retirement accounts, and whether it is ever a good idea to do so. The article cited some surprising statistics. For example, a new study by TIAA-CREF showed that one in three Americans with a retirement plan have taken out a loan from the savings in their plan. Among those who did, 43% have taken out two or more loans. Another recent study indicated that one in five 401(k) participants who were eligible for loans had outstanding balances against their 401(k) accounts in 2012.
Why are so many people adopting this strategy? According to Vanguard, 46% borrowed to pay debt; 35% to cover emergency expenses; 26% for the purchase of a home or to pay for a home renovation; 24% to pay bills following the loss of a job; 20% to pay for education; and 15% to pay for special events, such as a family vacation or wedding.
So, is borrowing against your retirement plan ever a good idea? According to the article, experts say it might be advisable to borrow to pay down debt or cope with emergency expenses, but you have to be fully aware of what you are doing and make sure that you are taking the money from the right place. “There are certainly situations where it is best to take out a 401(k) loan, for instance, when there is a medical emergency and a large expenditure on medical care cannot be covered using other assets,” says John Beshears, a Harvard University professor and co-author of a study on the subject, The Availability and Utilization of 401(k) Loans.
Others say 401(k) loans can be part of a sound financial plan. “I think loans, when used properly, can be a very important part of a successful plan,” says Mark Davis, a senior vice president with CAPTRUST Financial Advisors in Westlake Village, Calif. He adds that as long as the loans are repaid and participants continue to fully fund the plan while paying back the loan, there may not be a big downside.
Of course, loans such as these are not exactly “free.” Borrowers miss out on the capital gains they would have accrued, and loan repayments are subject to double taxation. And, if you are faced with the prospect of personal bankruptcy, it is advisable to keep the money in the 401(k) since it will be safe from creditors.
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