Think carefully before you borrow against your retirement plan — it might be cost effective in the short term but has some drawbacks.
This is one of the few types of loans that doesn’t require an application, let alone a good credit score, and in the short term it can be more cost effective than other types of borrowing, assuming your plan sponsor allows you to borrow in the first place.
You can borrow against 403(b), 457(b), 401(k) or a Roth IRA — but not all plan sponsors offer this capability, and the ones that do get to set their own interest rates. Only the solo 401(k) lets you do so without having to pay penalties or interest.
How Much Can You Borrow Against Your Retirement Plan
Among the plans that offer loans, the IRS limits borrowing against them to “(1) the greater of $10,t000 or 50% of your vested account balance, or (2) $50,000, whichever is less.”
You can take out more than one loan at a time but the total amount of outstanding borrowed funds must not exceed the maximum stipulated by the IRS.
The interest charged on loans against retirement plans are set by the plan sponsor. But if you decide to just cash out altogether by withdrawing funds early, rather than borrowing, you pay a 10% penalty if you’re below age 59.5.
That 10% does not include taxes, and unfortunately these withdrawals are taxed as income, according to the bracket you fall into.
A retirement plan withdrawal has the potential to move you into a higher tax bracket for the year — and the boundaries between each of the brackets has moved under the newly enacted Tax and Jobs Act.
As alluded to earlier, borrowing from a solo 401(k) is cheaper than other types of loans in the most literal sense that there’s no interest nor penalty.
Make It Short Term
However, the longer you take to repay the loan, the more of an opportunity cost you incur because your money is not getting the chance to accrue value through being invested in the market.
If your credit score is less than perfect, you might find borrowing from your retirement plan to be a great deal cheaper than any other type of loan.
Although lenders have eased up their guidelines for approving loans in recent years, it’s entirely possible you still might not qualify for any loan at all if your credit score is below 600. This might leave you no other choice but to borrowing against your retirement plan.
Should You Take on This Debt?
But if you have no other way to borrow money, rethink whether taking on any additional debt will help your situation — it may not help.
You may gain some clarity about this decision by obtaining the total cost of borrowing from your retirement plan — this calculator helps you arrive at that.
Have you thought about borrowing from a retirement plan as an alternative to another type of loan?
Get Your FREE Book Now
Enter your name and email address below to get your free copy of "How to Hack Your Spending."