More Money Regrets: Borrowing From Your Retirement Plan

BOSTON (CBS) – Here again some listeners tell of getting screwed. They borrowed from their plans, left their employment and the money was owed back within 30 days or it became a withdrawal. With no money available to pay it back they ended up owing taxes and a penalty for many were under 59½.

Most 401(k) plans and some 403(b) and 457 plans allow the participant to borrow from their plan. According to the Employee Benefit Research Institute’s latest study on borrowing, more than 20% of participants have outstanding loans from their plans.

The maximum you can borrow from your account is 50% or $50,000 whichever amount is smaller. And sometimes there is a minimum such as $1,000. There are also fees associated with borrowing for there is paperwork involved. And often it is a short term loan of five years.

Over 80% of 401(k) plans allow borrowing, the thinking here is that the employee will be more likely to contribute to the retirement plan if they are allowed to get at the money thru borrowing. It could very well be a selling point but I am not a big fan of borrowing.

It sounds so good, borrow from yourself and pay yourself back! When you do the actual math it doesn’t work that neatly.

You borrow money you contributed to the plan; these are dollars you have not paid taxes on for they went into your account pre-tax. You pay back the loan with after tax dollars. Then in retirement you withdraw the money as a good citizen should and you pay income taxes again on it. You have double taxed yourself on your money.

And what if you lose your job? Either because you have been downsized or are ready to move on to another job? You are required to pay back the outstanding loan within 30 to 60 days. For most people the reason for borrowing was that they did not have money in the first place so now they can’t pay back the loan.

The outstanding balance is now considered a withdrawal from your retirement plan and you will owe income taxes on the amount outstanding when you file your tax return and if you are under the magic age of 59½ you will also owe a 10% penalty on top of the taxes!

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Comments

One Comment

  1. Mary Nikko says:

    You should not use your retirement funds for non-retirement needs unless it is an emergency and you have no other way to get the money you need. You should not purchase expensive items, pay for your children’s college or other costs unless your retirement nest egg is fully funded and secure. The closer you are to retirement the less likely that you will be able to replenish your retirement funds and the compounding lost from withdrawals. I read several related pages and posts on retirement planning and investing on the site Retirement And Good Living. The site provides information on many retirement topics and has several retirement and health calculators.

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