While most retirement industry experts agree that workers should limit the loans they take out from their 401(k) plans, one certified financial planner thinks that in some rare cases, taking a loan from your retirement plan can be a good idea.
In a recent blog by Scott Spann of Financial Finesse, he looked at the advantages of taking out a 401(k) loan:
- There is no credit check. Loans made from a retirement plan balance won’t hurt your credit because the money was yours to borrow.
- Interest rates are often lower than other personal loans available in the marketplace. Spann points out that loans from a 401(k) usually have low interest rates — currently 3.25 percent — linked to the Wall Street Journal prime rate. The average credit card interest rate is 15 percent, so using your 401(k) money to pay off high interest credit card debt could be a good idea.
- You don’t have to pay taxes on loan proceeds. Loans aren’t considered a taxable withdrawal, he said.
The disadvantages to taking a loan from your 401(k) outweigh the advantages, according to Spann. They include:
- Investors could lose potential future earnings growth by withdrawing that money.
- Retirement plan loans are deducted directly out of your paycheck as an after-tax deduction, which could have a negative impact on your take-home pay.
- You could owe taxes and penalties if you leave your employer before repaying the loan.
- If you don’t make changes to the way you spend money, you could end up with additional credit card debt down the line.
Spann concluded that even though there are some advantages to using retirement money to pay off other debts, like credit cards or a home mortgage, investors should leave their money where it is, only taking out a 401(k) loan as a last resort.