The latest iteration of the Employee Benefit Research Institute’s Retirement Confidence Survey included a large slice of currently serving military and veteran respondents. Given today’s difficult economic environment, mixed news on one front — how many households borrowed from their retirement savings — wasn’t surprising.
Overall, military-affiliated respondents were less likely to dip into their retirement savings, but they were more likely to do so for a certain purpose.
The military respondents were 20% less likely to have borrowed from their Thrift Savings Plan (TSP), 401(k) or other employer retirement plan than those without a military background. In my mind, that’s a good thing.
On the other hand, military borrowers were 25% more likely to have borrowed for the purpose of making home or car repairs. To me — and this may be a leap — this would seem to indicate that the borrowers did not have an adequate emergency fund in place.
Again, a mixed bag, but the big news is that those who wear or have worn the uniform, based on this particular survey, appear less likely to have tapped their retirement savings.
Let’s explore those retirement plan loans as an option. If you need cash, borrowing from your plan at work may seem tempting. After all, most offer loans up to half of your account value, or $50,000, whichever is less.
Here are what I see as the pros and cons of tapping your employer’s retirement plan via a loan:
Pros
Here are some of the positive aspects of a retirement plan loan:
- It’s easy. You typically fill out a form and have the money in a few days. There’s no credit check or drawn-out application process. You usually make payments via payroll deduction.
- It’s competitive. The interest rate is usually low, especially compared to a credit card or unsecured loan. For example, a typical rate might be the prime rate plus 1%. That’s not as attractive today as it was just a couple years ago, but it’s still a reasonable 9.5%.
- The interest goes to you. You keep the interest you pay, not a lender.
- Its use isn’t restricted. Simply put, you can use it for anything.
- It’s got a definitive end. Most plans allow you to set up your repayment schedule from 1-5 years (perhaps longer in some situations, for example if you’re buying a home), which can provide the light at the end of the tunnel if you’re consolidating other debts.
Cons
On the other hand, here are some of the potentially negative consequences of borrowing from your retirement:
- It could reduce what you’re saving. This may be the scariest aspect of borrowing from a work retirement plan. Some plans forbid contributions while the loan is being paid back. Even if that’s not the case, it just follows that those with a loan would reduce or eliminate their contributions during the payback period. Bad idea.
- The bull could pass you by. If the markets go up, you could miss out on the growth your loaned money might have earned. However, if the markets head south, that low interest rate you’re paying yourself may not look all that bad.
- Job loss requires payback. In most situations, you’re required to pay back the loan within 60 days if you leave the employer. If you’re unable, the outstanding balance could be subject to taxes and early-withdrawal penalties.
- It could be habit forming. While a 401(k) loan may be an appropriate borrowing option in certain situations, you don’t want your 401(k) to become a piggy bank. It’s intended for retirement. Your emergency fund (hopefully) or other savings should cover shorter-term needs.
- It doesn’t fix the core issue. Using a 401(k) loan to pay off other debts or extend your lifestyle can be a financial disaster. I’ve worked with people who have consolidated their debt only — because they hadn’t fixed the reasons they went into debt in the first place — to end up with both the consolidation loan and a whole bunch of new debt they piled on after they “fixed” their problem through consolidation.
In the end, it’s your call. Remember, with the Secure 2.0 Act, retirement plans may offer small emergency fund withdrawals as another option. Whatever you do, focus on maintaining your retirement savings momentum.
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