— The temptation to take loans from a company 401(k)
retirement savings plan is apparently too hard to resist
for some people even after they’ve been warned of how
dipping into that account can knock their retirement
plans off track.
addition to the loss of compounding interest, there are
other potential downsides or perils of utilizing a loan
provision from a 401(k)," said Curt Knotick, owner
of Accurate Solutions Group outside Pittsburgh.
"One would be taxes — more importantly, paying
double taxation on the interest you pay for the loan
research by the Federal Reserve Bank shows a small
percentage of workers use their 401(k)s as a honey pot
to fund vacations and live beyond their means, the
majority of such loans are used to make downpayments on
homes, consolidate high interest credit card debt, buy
cars and pay for educational and medical expenses.
in recent years, it seems a growing number are a last
resort to handle emergencies when the account owners are
out of cash and out of options for getting what they
recent report by the Investment Company Institute in
Washington, D.C., showed loan activity from company
401(k) plans is higher today than it was seven years
ago. As of the end of September 2015, 17.6 percent of
401(k) plan participants had loans outstanding, compared
to 15.3 percent with outstanding loans at the end of
increasing number of workers taking loans from their
retirement accounts could be a sign of financial stress,
said Sarah Holden, senior director of retirement
investor research at ICI.
some individuals, it may make more sense to take
advantage of the 401(k) loan and pay yourself back
rather than pay some other lender," she said.
all 401(k) participants have access to a loan feature.
The Center for Retirement Research at Boston College
estimates about 90 percent of employers offer loans.
Internal Revenue Code limits the borrowing to 50 percent
of the account balance up to $50,000. Loans do not
require approval, but generally must be paid back within
one to five years.
such loans do come with risks. If a 401(k) loan is not
repaid due to default or job loss, the remaining balance
is treated as a lump-sum distribution and is subject to
income taxes and a 10 percent penalty for borrowers who
have not reached age 59 1/2.
said there is another tax issue that many people don’t
take into consideration.
will be paying back the loan with interest and using
after-tax dollars to pay that interest," he said.
"Then once back in the 401(k) account, when you
withdraw those funds for retirement in the future, you
will be paying taxes again — since with a traditional
401(k) account, withdrawals are taxed at the time of
401(k), which came onto the scene in 1978, has primarily
replaced company pensions as the dominant workplace
retirement plan. Pensions provided a monthly fixed
income for retirees. The idea behind a 401(k) also is to
create income for workers in retirement, which is why
financial advisers typically consider such funds off
limits until retirement.
we exercise a loan from our 401(k) which is to be
utilized for retirement, we lose the compounding of
those dollars, since they are no longer in the
plan," Knotick said. "That can have a dramatic
impact over the course of 10, 15 or even 20 years. Don’t
underestimate that impact, which can literally be
thousands of dollars.
the 401(k) was created to plan for retirement, and not
for use prior to then.