Saving for retirement is one of the largest financial goals most people will work toward throughout a lifetime. As people are living longer, the need to accumulate a substantial amount in retirement-specific accounts is pressing. Fortunately, there are several accounts that are earmarked for retirement purposes that allow for easy contributions directly from a paycheck or a linked bank account. A large portion of retirement savings is put into employer-sponsored plans each year, such as a 401(k) or a 403(b), while others focus their savings in individual retirement accounts, including traditional and ROTH IRAs.
Regardless of where retirement funds are stashed, there are moments where one may consider borrowing from an account to cover an unexpected bill. Although every situation is different, there are several reasons to avoid depleting retirement savings, and a few where it may be beneficial to do so.
When Not to Borrow
Retirement plans made available through an employer represent the easiest way to save for the long-term goal of retirement. Employees select a percentage or specific dollar amount to be withheld from their earnings each pay period, and the funds are directly deposited into the retirement plan offered by the employer. Some employer-sponsored plans allow for loans against an accumulated balance, but there are a handful of scenarios where borrowing from a plan does not make financial sense.
Nearing retirement: if you are within a few years of leaving the workforce, it is rarely a smart strategy to borrow from a retirement plan to pay for unanticipated or known expenses. Most plans have a stipulation that when a loan is taken from an employee’s available balance, no contributions can be made until the loan is repaid in full. Being on the cusp of needing to draw an income from retirement savings means continuing to make contributions is crucial to retirement success. Loans prohibit this from occurring in most employer-sponsored plans.
Access to alternatives: most people consider taking a loan from a retirement plan when cash flow is tight, or the need for covering a large expense arises. Although it can seem smart to borrow from the money you have saved over time, another loan, home equity, or low-interest credit card options may be a better option. If the amount needed is relatively small, a shorter-term loan from a local lender can be a smart choice, while larger amounts may be borrowed from a home equity line of credit or another credit line. These options allow your retirement funds to remain invested where they are, in an ideal world, generating a return. Borrowing through more traditional vehicles also allows for contributions to continue into a retirement plan which is necessary for reaching a retirement goal.
When Borrowing is an Option
The ability to borrow from an employer-sponsored retirement plan is available for a reason, and the option does have some benefits over other borrowing alternatives. Loans from retirement plans are often available at low-interest rates compared to credit cards or personal loans, and repayment can be extended for ten years or more in some instances. Individuals best suited for a retirement plan loan are those who have a number of years before they plan to retire as well as a large need for low-cost funding. For instance, borrowing from a retirement to help with a down payment for a home or to fund a child’s college tuition may be beneficial in the long run, more so than other means of borrowing. However, before making a decision on way or the other, you should fully evaluate each of your options to understand the cost, the advantages and disadvantages, and the requirements for repayment over time. When possible, save retirement plan borrowing as a last resort resource for covering unexpected bills.