Ask Stacy: Should I Borrow From My Retirement Account to Pay Debts?


What's Hot


2 Types of Black Marks Might Vanish From Your Credit File SoonBorrow

6 Ways the Obamacare Overhaul Might Impact Your WalletInsurance

7 Dumb and Costly Moves Homebuyers MakeBorrow

This Free Software Brings Old Laptops Back to LifeMore

Obamacare Replacement Plan Gets ‘F’ Rating from Consumer ReportsFamily

Beware These 12 Common Money MistakesCredit & Debt

21 Restaurants Offering Free Food Right NowSaving Money

17 Ways to Have More Fun for Less MoneySave

House Hunters: Beware of These 6 Mortgage MistakesBorrow

30 Household Uses for Baby OilSave

25 Ways to Spend Less on FoodMore

Nearly Half of Heart-Related Deaths Linked to These 10 Foods and IngredientsFamily

5 Surprising Benefits of Exercising Outdoors in WinterFamily

10 Ways to Save When You’re Making Minimum WageSave

Boost Your Credit Score Fast With These 7 MovesCredit & Debt

7 Painless Ways to Pay Off Your Mortgage Years EarlierBorrow

The Most Sinful City in the U.S. Is … (Hint: It’s Not Vegas)Family

The True Cost of Bad CreditCredit & Debt

10 Companies With the Best 401(k) PlansGrow

This Scam Now Tops ID Theft as the No. 2 Consumer ComplaintFamily

6 Stores With Awesome Reward ProgramsFamily

6 Ways to Save More at Lowe’s and The Home DepotSave

6 Healthful Treats for Your DogFamily

New Study Ranks the Best States in the U.S.Family

Thousands of Millionaires Moving to 1 Country — and Leaving AnotherGrow

Strapped for College Costs? How to Get the Most From FAFSABorrow

6 Overlooked Ways to Save at Chick-fil-AFamily

Ask Stacy: What’s the Fastest Way to Pay Off My Mortgage?Borrow

Where to Sell Your Stuff for Top DollarAround The House

8 Ways to Get a Good Price on a Shiny New AutoCars

Ask Stacy: How Do I Start Over?Credit & Debt

Secret Cell Plans: Savings Verizon, AT&T, T-Mobile and Sprint Don’t Want You to Know AboutFamily

30 Awesome Things to Do in RetirementCollege

14 Super Smart Ways to Save on TravelSave

The Rich Prefer Modest Cars — Should You Join Them?Cars

You’ll Soon Pay More to Shop at CostcoSave

10 Ways to Save When Your Teen Starts DrivingFamily

One in 5 Americans able to borrow from their 401(k)s have done so. But that doesn't mean it's a great idea.

Nobody wants debt hanging over their head, especially the high-interest kind. Among the options available to destroy it, doesn’t it make sense to borrow from yourself?

Here’s this week’s reader question:

My question is, I have some money in my retirement account. Is it better to borrow some of that money to pay down debt if you don’t have any other additional financial resources coming in to pay down the debt, or should you keep funding retirement and paying down the debt slowly as best as you can? — Stephanie

Before we get to Stephanie’s question, here’s a video I did a while back about digging out of debt. It’s one of my favorites because it’s the only news story I’ve ever done while wearing a Hawaiian shirt.

Now, on to Stephanie’s question:

Can you borrow from your retirement plan?

The law allows loans from common qualified retirement plans, like 401(k)s and their nonprofit cousins, 403(b)s. But while the law allows loans, plans aren’t required to offer them. So first see if your plan allows loans, and if so, what kind. For example, some plans only allow hardship loans, meaning you’ll have to be in dire straits, like facing eviction, to qualify. Others allow you to borrow for any reason.

The most you can borrow from most qualified retirement plans is the lesser of $50,000 or 50 percent of your vested balance, although some plans have an exception that allows loans of up to $10,000 even if 50 percent of the vested balance is less than $10,000.

The longest you can take to pay the loan back is five years, longer if the loan is to finance a house.

You’ll pay interest at the rate established by the plan. But the interest you pay goes into your account, so you’re paying it to yourself. Doesn’t that beat borrowing from a bank, or paying 20 percent on a credit card?

You’d think so, but let’s go over the drawbacks.

Why borrowing from retirement accounts is bad

  1. You’re putting the brakes on your savings. Many retirement plans prohibit making additional contributions to your account until the loan is repaid. So when you borrow, you’re not building your retirement savings. And even if you can continue contributing, can you afford to do that and make payments at the same time?
  2. You’re not making as much. Sure, you’re paying interest to yourself on the amount you borrowed. But that interest may not be as much as the returns you could have achieved in stock mutual funds or other investments in your account. You’re obviously also not making money on the money you could have contributed, but now can’t.
  3. You’re repaying the loan with after-tax money. When you make regular contributions to your retirement account, those contributions aren’t taxed. But when you pay back your loan, the income you’re using is after-tax. For example, if you’re in the 25 percent bracket, you’ll have to make $100 to pay $75 of your loan. And the interest you pay isn’t tax-deductible.
  4. Better be able to pay it back. Should anything arise that prevents timely repayment of the loan, it can become a withdrawal, subject to income taxes and a 10 percent penalty.
  5. Better love your job. If you lose your job, you’ll have to pay the money back quickly, typically within 60 days. Otherwise, as above, you’ll be both taxed and penalized.
  6. There could be a loan origination fee. Ask your employer.

There are calculators online that can help you determine the impact of a 401(k) loan on your retirement savings, like this one from Vanguard.

When borrowing from retirement accounts makes sense

You’d think after reading the above that nobody should ever borrow against a retirement plan. Yet, it’s common. According to the Employee Benefit Research Institute, about 20 percent of those eligible for a 401(k) loan at the end of 2014 had one. Here are some examples of when they might be appropriate:

  • When you have no other choice. If your back is against the wall and you have no other options, the decision is easy.
  • When it’s the best you can do. If you really need money, these loans may be the least expensive way to get it, in terms of interest, fees and convenience.
  • When the math works out. If you’re paying 21 percent on a credit card and repay your retirement account at 5 percent, you’re obviously money ahead by borrowing. And this can be especially true if …
  • Your investments are about to crash. When you take money out of your retirement plan, or are paying off a loan with new contributions, that money isn’t available to earn anything in whatever investments you’ve selected. The more the market takes off after you remove and pay back the money, the higher your opportunity cost. But if the market goes down, you were certainly better off using the money to pay off a 21 percent credit card than watching your balance crater. If your investments have doubled over the last several years, this is a backdoor way of locking in some profits.

Check Out Our Hottest Deals!

We're always adding new deals and coupons that'll save you big bucks. See the deals to the right and hundreds more in our Deals section.

Click here to explore 2,078 more deals!