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Borrowing From Your Retirement Plan

Some retirement plans allow you to take a loan from your savings. But, should you? The answer is: it depends. Let's take a look at some considerations.

Consideration #1: Have you done your research?

Retirement plan loans are convenient; for one thing, you aren't subjected to a credit check. However, there may be other options for borrowing money. Have you been building up your emergency fund — you know, that savings account with three to six months of living expenses? You could use that first, especially if you need money for an unexpected expense like a medical emergency.

Another option to consider is turning to a family member for a loan. If you're a home owner, you may want to consider a home equity loan because interest may be tax-deductible. The bottom line is that taking a retirement plan loan should generally be a last resort.

Consideration #2: What's your backup plan?

When you leave or lose your job for any reason, you may have to pay your outstanding loan balance within a specific timeframe, typically 60 days, depending on the plan rules. If you don't, you are required to pay income taxes on the outstanding balance and you may be subject to an early withdrawal penalty. Most people in this situation don’t pay back the loan and end up with a tax bill and penalty — as well as a much smaller amount in their retirement account.

Consideration #3: Do you know what it will cost?

There are costs associated with taking a retirement plan loan, such as possible set-up and maintenance fees. Also, while your money is out of your account, it isn't earning anything, and the interest part of your loan payment isn't tax-deductible like it is with certain other kinds of loans.

If you decide to take a loan

If your plan allows loans and you decide it’s the best choice for you, there are simple steps you can take to avoid some of the pitfalls. Consider these tips:

  • Check your plan loan rules before you borrow.
  • Borrow only what you need.
  • Keep saving — continue contributing to your retirement account while you pay back your loan.
  • After paying back the loan, start an emergency fund so you won't need to dip into your retirement account again.

Fast facts about retirement plan loans

  • You pay interest and typically a setup fee; interest rates may be lower than on a standard bank loan.
  • If you leave your job, you usually have to pay the loan back within 60 days or face possible taxes and a penalty.
  • Generally you have five years to pay the loan back, possibly longer for a home purchase.
  • You'll pay the loan back on an automatic schedule; payments come directly out of your paycheck.